Written in Crain's by Steve Daniels
The co-founders of a Chicago startup want to solve a problem they themselves experienced: running out of money to pay for college close to the finish line for obtaining a degree. And they've got two well-known, deep-pocketed firms backing the venture—Bank of New York Mellon and Chicago venture-capital firm Lightbank.
A.M. Money, launched by Chicago natives Daniel Rogers and Jeffrey Wright, has an agreement with BNY Mellon to underwrite $100 million in bonds financing 10-year loans the firm will make to Chicago college students beginning this year. That will enable up to 8,000 students at schools like the University of Illinois at Chicago to obtain loans at roughly the same interest rates the U.S. government charges, and without needing parents or others to co-sign.
The tax-exempt bonds are the kind customarily issued by state or municipal governments. Student lending is a category of financing for which the private sector is permitted to float tax-exempt bonds, but it's rarely done.
This first batch of loans will be a major test. If they're collected without significant losses, the firm expects to use the same financing mechanism again—likely in cities other than Chicago. For now, Chicago is the focus.
For Rogers and Wright, this is personal. Unable to afford college, Rogers, 36, joined the Army after graduating in 2001 from Kenwood Academy on Chicago's South Side and completed the equivalent of six college credits while stationed in Iraq. He describes the incongruity of days going out on missions and nights writing papers on purely academic subjects.
When he returned home, he attended American University. In his junior year, he ran short of money to finish and begged his grandmother to co-sign a $16,000 loan at 12 percent to graduate.
Wright, 34, grew up in Chicago’s Austin neighborhood and then went to Georgetown University. He, too, needed a private loan beginning in his junior year, and asked seven family members and mentors before finally getting an uncle to co-sign. His parents didn’t have strong enough credit to do it.
"People don't understand the scale of this problem," Wright says. The loans won't be available for students who haven't yet begun college. Instead, they are for those who are at least juniors and have excellent grades at four-year colleges and universities. "That's the kid we want to make the bet on," he says.
Targeted local schools, apart from UIC, include the University of Chicago, Northwestern University, DePaul University, Loyola University Chicago and others. There are more than 65,000 undergrads in those institutions, with the average unmet financial need per student of more than $20,000, according to data compiled by Lightbank.
Lightbank believes the national market for students in need of these bridge loans to finish school is between $11 billion and $15 billion, says Eric Ong, vice president at Lightbank and the firm's point person on the transaction. "It's a big market, and no one's going after it," he says.
Neither Lightbank nor A.M. Money would disclose the amount of Lightbank's equity investment. Likewise, a Bank of New York spokeswoman says no one there can discuss the bonds financing the loans due to securities law restrictions.
Several large banks have expressed interest in underwriting future bonds to finance these loans, Ong says. He expects numerous banks to get involved, assuming A.M. Money establishes the business model.
"We're really, really bullish about it," Ong says.
The key to the product is that no co-signer is required. The private lending industry typically demands that parents or others shoulder the risk if a borrower doesn't repay the loan over a period ranging from five to 20 years. And rates are generally higher than the 7 percent or so A.M. Money is charging.
For example, interest rates on student loans at one of the nation's largest private student lenders, Riverwoods-based Discover Financial, averaged 8.59 percent in the second quarter, according to investor disclosures.
Underwriting is relatively straightforward. The questions the firm asks and attempts to answer are, "Who is going to graduate? Are they employable?" Rogers says.
The federal government keeps statistics on the performance of loans at specific colleges. Students at schools that perform well are eligible for A.M. Money loans. Those at online schools or for-profit colleges don't qualify.
Students provide their transcripts. Those with good grades at qualifying schools get loans. "Most of the process is automated," Rogers says.
Private lending without a co-signer sounds risky. Nationally, for students who began paying off their debt in 2013, the most recent default rate on federal loans was 11.3 percent. For four-year, public institutions, the average default rate for students who attended four or more years was 7.3 percent, according to the U.S. Department of Education.
But, essentially, A.M. Money is betting on the quality of the schools whose students it's willing to bankroll.
UIC, for example, has a student default rate of 2.8 percent for the group that began repaying their loans in 2013, according to the Department of Education. The University of Chicago's student default rate from the same year is just 0.9 percent. And Northwestern's is 1.3 percent.