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.
Then a second critical source of funds collapsed. Many student lenders receive funding through auction-rate securities -- variable-rate bonds that are put up for bid as often as once a week to determine their interest rate. Normally, the bidding process produces a lower rate than that of traditional bonds. But over the past few months, as the credit crisis spread across the financial system, bidders have been unwilling to buy these bonds except at high rates.
Now, only student lenders with large cash reserves, such as banks, may be able to survive. "We have an impending crisis in terms of loan availability," Kantrowitz said.
At least one firm, the Education Resources Institute, has filed for Chapter 11 bankruptcy protection. Revenue for the firm, which provided insurance for private loans, evaporated when these loans could no longer be securitized, said Willis J. Hulings, the company's chief executive. Meantime, the firm also had to cover increasing defaults.
Federal officials said that most students will still be able to get federally guaranteed loans. In addition, a few major lenders, including J.P. Morgan Chase, said they plan to expand their lending business in an effort to take a larger market share.
Spellings said that her staff is try to ensure that federal loans will be available to students this fall. She plans to meet tomorrow with about 30 designated lenders to provide guidance on the department's emergency lending program. Late last month, she huddled with senior Treasury officials to make sure the initiative would have enough funds.
"We are all aware that there are serious issues in the economy and credit markets that have implications in the marketplace, in car loans and student loans," she said. "Obviously as the secretary of education, I'm most concerned about kids going to school this year."
If firms continue to get out of the lending business, the federal government could expand the number of loans it provides to students, Spellings said. In addition to federally backed and private loans, there is currently $12 billion worth of direct loans that the government makes to students through their schools. Spellings added that the government is prepared to do more.
She said many families are confused by the complexity of student lending and overlook lower-rate federally guaranteed loans. She said she hoped the mounting attention to this troubled lending sector would lead to improvements.
"Families should have concerns about big tuition increases, year over year, and our broken financing system," she said. "It's as if we are trying to keep kids out of college."
The bills in Congress seek to address these issues by increasing the amount of grants available to the poor and raising the cap on how large a federal loan students can take out. Federally backed loans now cover 25 percent of the cost of higher education, Spellings said.
Some education advocates said the congressional proposals needlessly alarm students.
"The congressional action and the media coverage on this issue is doing a massive disservice to students and families, many of whom are concerned about paying for college already," said Luke Swarthout, higher education advocate for the U.S. Public Interest Research Group. "We know many of them are adverse to debt, and for lenders to be sending out a message of crisis in order to secure themselves a bailout potentially could dissuade families from seeking available financing options."
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