Exit of College Lenders Sets Off Scramble To Fill Breach

By David Cho
Washington Post Staff Writer
Thursday, April 10, 2008

Nearly 50 student lenders, including some of the industry's biggest names, have stopped issuing federally guaranteed loans in recent weeks because of paralysis in the credit markets, confronting students with higher borrowing costs just as they are starting to apply for financial assistance for the coming school year.

These companies represented 12 percent of the market before they left, and analysts say this is just the beginning of an exodus. That is because virtually all student lenders have been shut out of their traditional funding sources on the debt markets. Dozens of other lenders that offer private loans, which have no federal backing, have also dropped out.

The escalating problems have persuaded the Education Department to prepare a "lender of last resort" program, which would provide emergency funds to a few dozen lenders designated to help students who are unable to secure federally backed loans.

"This is the equivalent of a hurricane coming, and staging food and water at the site," Education Secretary Margaret Spellings said in an interview. "Our responsibility is to be prepared for every eventuality."

Some colleges are already saying that their students' expected financial needs for the fall semester are outstripping what lenders are willing to provide. The industry's downturn could mean that no loans are available for a fraction of students with bad credit histories or who are attending for-profit educational institutions with poor graduation rates.

"Schools are telling us they are starting to scramble, that they are being told by their lenders they won't be able to handle the volume of loans," said Rep. George Miller (D-Calif.). "They think there will be a gap between supply and demand."

Lawmakers on Capitol Hill want to give the Education Department the authority to buy up federally backed loans from lenders, which could help thaw the frozen debt markets and rescue cash-strapped firms. Yesterday, the House Education Committee, which Miller chairs, approved such legislation with bipartisan support. A similar measure was introduced in the Senate last week.

"The turmoil in the credit markets has become a crisis for some lenders -- the question for Congress is how to prevent it from becoming a crisis for students," said Sen. Edward M. Kennedy (D-Mass.), who introduced the Senate bill. He said that these bills would "ensure that students and families continue to have multiple options for securing the funds they need for college this fall, even if the situation should take a turn for the worse."

The tumult is likely to push hundreds, if not thousands, of firms out of the student lending business, said Mark Kantrowitz, publisher of FinAid, a Web site that provides financial advice for students. Of particular concern is the number of firms leaving the business of making federally guaranteed loans, which, besides parents, are the primary source of financing for students' higher education.

The list of dropouts includes such major players as College Loan Corporation, HSBC Bank, CIT Group and Washington Mutual. Among the 100 largest lenders, which represent 92 percent of the federal loan market, 19 have left. In addition, firms have cut nearly 2,300 jobs.

There are two major kinds of student loans. One, which is federally guaranteed and offers a public subsidy to lenders, has a fixed interest rate set by the government and accounts for about $47 billion in student debt. The other type can command a higher rate determined by the market but has no such guarantee or support. These loans are estimated to represent $18.5 billion, and their rates have been climbing during the credit crisis. Both types of loans can be issued by a variety of lenders, including banks, private companies and state agencies.

Most lenders rely on the securitization of debt to generate enough cash to issue student loans. This process turns ordinary loans into securities, just like stocks, so they can be bought and traded on the debt markets. But lenders have been unable to securitize any loan made after Oct. 1, when a cut in federal subsidies to lenders went into effect. A few weeks later, the credit crunch that began among troubled mortgage securities started to ripple across the student loan industry. Both developments dried up investor appetite for student loans.

CONTINUED     1        >

© 2008 The Washington Post Company