January 29, 2016
Latham, SoFi and the Student Loan Disconnect
Posted by Christine Hurt

Generally, in personal or corporate lending, interest rates reflect individualized risk.  A seasoned company with years of positive cash flow and great collateral will have a lower cost of borrowing than a company with a rocky history that is highly leveraged.  And, of course, anyone who watches cable TV can assume that an individual's credit score will affect the interest rate they will pay for a car loan, mortgage, personal loan, etc.  However, federal student loans come in universal interest rates for undergraduates and graduate/professional students, regardless of the student's school, degree program, grades, or eventual job offer.  And, these rates are fairly high, even though they were lowered under the Obama administration.  The rates for law student federal loans are now 5.84% and 6.84%.  Considering that the prime rate is 3.5% and a 30-year fixed mortgage rate just a smidge above that, these rates seem sort of crazy for low-risk students.

Last Spring, I was at a conference at UC-Santa Cruz (finance department), and the keynote speaker was Mike Cagney, CEO of SoFi (Social Financial).  The backstory of SoFi as he told it was that he realized that students at Stanford (I think Stanford Business School) were paying the very high federal student loan rate, but that there had not been a default of a domestic Stanford (business?) student in 20 years.  So, he arranged for peer-to-peer lending between Stanford alumni and students to refinance those loans at a more competitive rate.  With interest rates so low, it was not a hard sell to the alumni that they could get a low-risk investment that returned 2.5% and helped out a fellow Stanford alum.  Now, SoFi is venture-backed and no longer peer-to-peer.  It has also grown and spread into other lending areas where there is a disconnect in this low-rate investing but strict criterial lending environment.  Cagney also spoke of how banks' criteria is biased against his favorite low-risk group -- HENRYs (High Earners, Not Rich Yet).

Latham & Watkins is in the news this week for seeing the same disconnect in its new associates, who were knee-deep in high-interest student loans but were low-risk due to stable, high-income employment.  So, Latham arranged with First Republic Bank and SoFi to refinance $13M in student loans for over 100 associates (that's a lot of debt-per-associate) at "rates as low as 2.5%."  The details were not in the news, but it would be interesting to see what credit support Latham gave, if any.  First Republic might have seen this as a private banking opportunity, just as many commercial banks lend to law firms to get the private banking business.  Or, Latham may have provided some sort of guaranty support.  That seems fairly risky for Latham, though.  Also, I wonder if the bank loans are contingent on the associates remaining employed at Latham.  The SoFi refinancings seem more like SoFi's stock-in-trade.  (SoFi seems to sell its student loans into the securitization market.)

I wonder why other employers don't see the same opportunity.  I can see in a cynical way that employers may like associates with high debt because then "golden handcuffs" may appear even more golden, but a lower interest rate probably isn't going to enable associates to retire early to write that novel.  I could also see employers with a lot of cash refinancing the loans themselves.  With paycheck withdrawals, the loans would be pretty low-risk, and it's hard for most law firms to make 2.5 to 3.0% on their money these days.  I also wonder why more law schools with large endowments don't self-finance for the same reason.  (Though, according to Vic Fleischer, schools with super-large endowments pay hedge fund managers to get a higher return than that.)

And yes, I understand that law school grads who refinance give up the benefits of the federal student loan program -- deferral for unemployment and health reasons, discharge for disability or death, and income repayment and forgiveness plans. 

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