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Sallie Mae Forecasts Surge in Defaults

By Alejandro Lazo
Washington Post Staff Writer
Friday, January 23, 2009

Sallie Mae said yesterday that it expects a spike in defaults this year on its equivalent of subprime student loans as the economy continues to deteriorate and borrowers are unable to make payments.

The Reston company, which is the nation's largest student lender, said defaults on its portfolio of so-called non-traditional loans increased near the end of 2008.

Like subprime loans, these loans are considered risky for lenders and thus carry a higher interest rate than traditional loans. Among the factors that make them risky are that the students are attending programs with low graduation rates or are studying for jobs with a low income relative to their tuition.

Sallie Mae, formally known as SLM Corp., stopped making such loans in January 2008 after experiencing heavy losses on them. But it retains some in its portfolio.

Top Sallie Mae executives, in a conference call with investors yesterday, said that defaults on this portfolio were likely to peak this year, largely due to the worsening economy. In addition, the problem could be exacerbated by a decision last year to limit the ability of some of these borrowers to take advantage of a type of grace period known as forbearance.

"We see an acceleration of non-traditional losses in 2009, even somewhat beyond what we were expecting," Albert L. Lord, Sallie Mae vice chairman and chief executive, said on the conference call. "We also believe the year 2009 will be the peak of such losses, and the acceleration of those losses may well be precipitated by the company as it further refines its forbearance requirements."

These non-traditional loans, which were made by various lenders during the boom years, were part of New York Attorney General Andrew M. Cuomo's 2007 investigation into the close relationship between student loan companies and universities. As part of that investigation, Cuomo found that lenders often would make such loans available to students in exchange for certain benefits from universities.

Sallie Mae said yesterday that while it ceased its non-traditional loan program last year, the loans continued to disproportionately affect the company's profitability. Non-traditional loans accounted for 54 percent of charge-offs in the company's portfolio in 2008 while making up only about 14 percent of its private loan portfolio, the company said.

The company did not provide further details on how it had changed its forbearance criteria. Mark Kantrowitz, the publisher of the Web site FinAid.org, said that forbearance typically helps only when a student cannot make payments due to a temporary situation, such as a job loss.

"The problem occurs when the forbearance is used to address a structural income deficit -- a person has a job but their job doesn't pay them enough to allow them to pay their debt," Kantrowitz said.

The private student loan industry has been hard hit by the financial meltdown. Lenders such as Sallie Mae typically take loans and pool them into securities, which are sold to investors. Now fewer investors are willing to buy such securities.

Sallie Mae also said yesterday that it plans to participate in several new government-funding programs this year, including one in which the Department of Education will serve as a buyer of last resort for federal student loans. Additionally, the company said it intends to participate in a $200 billion program, created last year by the Federal Reserve and Treasury Department, that lends against highly rated securities backed by student loans as well as auto loans, credit card lending and small-business loans backed by the Small Business Administration. Sallie said it has about $30 billion worth of loans that are eligible for such programs.

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