the Lender Is a Borrower:
Unless you have a degree in finance, the current credit market upheaval—and how it impacts the student loan marketplace—may be a confusing topic for school staff. In a nutshell: since the money that students borrow to pay their tuition bill is needed up front (i.e., today) and the repayment of those loans is spread out over many years, student loan providers themselves must borrow funds from the capital markets. The overall financial goal of education lenders is to meet the needs of students by ensuring a stable, predictable source of funds in any interest rate environment.
While the details are complex, the general idea behind how lenders borrow from the capital markets can be easy to understand. Like other consumer loan providers who usually do not keep loans on their books for years, education lenders sell the loans into a trust, which sells securities (also known as asset-backed securities or ABS) to investors.
This process, called securitization, provides lenders with the original principal balance of the loans plus an upfront return on the investment, thus enabling them to make new loans. The investors who purchase the ABS are paid back over time by the payments of principal and interest on the underlying student loans. In other words, instead of having a lender’s resources tied up for many years and waiting for the payments from individual borrowers, this process allows lenders to continually put money right back into creating new loans for new students.
The ABS market has traditionally been very efficient because loans made under the FFEL program (i.e., Stafford, Plus, GradPlus) are guaranteed by the federal government and thereby offer a predictable and lower risk to investors than other types of consumer loans. But the sub-prime mortgage crisis has hurt the ABS market, making it difficult for many lenders, including education lenders, to get the funds they need to make student loans.
Education lenders also use the secondary market to raise funds. Most banks, for example, sell their loans to other non-bank education lenders. By tapping the secondary market, banks are able to free up the funds they need to make new loans. This process has also been impacted by the sub-prime mortgage crisis as a growing number of education lenders have had difficulty refinancing their holdings to free up money to buy additional loans.
In theory, the sub-prime mortgage crisis should have had little effect on student loans. But investors’ fear of purchasing mortgage-backed securities has spread to a general fear of all ABS, even those guaranteed by the federal government whose value is not in question. The result is that as demand for ABS has dropped, education lenders have had to offer much higher premiums to investors to encourage them to buy even a limited amount of securities. And that has resulted in dramatically higher borrowing costs.
At the same time, education finance companies have seen their rates of return on federal loans dramatically reduced by recent legislation. In 2007, Congress cut the Special Allowance Payment (SAP) paid to FFELP lenders, reduced the guarantee provided by the federal government in cases of default, and increased the lender-paid origination fees.
Student loan providers have felt the pinch of severe legislative cuts and a turbulent credit markets. More than one-third of the top 100 FFELP originators have left the student loan program, and lenders that accounted for nearly all FFELP consolidation volume have stopped making new consolidation loans, which will mean the Direct Loan program will need to pick up over $30 billion in dislocated consolidation loan volume, according to Department of Education estimates. In an April 17 call with investors, Sallie Mae CEO Albert L. Lord noted, “We can only meet the enormous student credit demands we are seeing at Sallie Mae if there is a near-term, system-wide liquidity solution.”
An injection of capital into the student loan marketplace has also been favored by leading policymakers and representatives for college and university financial aid professionals.
At an April 15 hearing on the topic, Sen. Christopher Dodd (D-Conn.), chairman of the U.S. Senate Banking Committee, urged government action, stating: “If the Fed and the Treasury can commit $30 billion of taxpayer dollars to enable the takeover of Bear Stearns by JP Morgan Chase, then surely they can step in to enable working families to achieve their dream of a college education for their kids.”
National Association of Student Financial Aid Administrators (NASFAA) President Philip R. Day, Jr. stated in an April 11 letter to members that “the lack of liquidity in the credit markets threatens to create a wide-spread Federal Family Education Loan Program (FFELP) loan access problem.”
Progress has been made. On May 7 President Bush signed into law the “Ensuring Continued Access to Student Loans Act of 2008,” which provides the Department of Education, at no cost to taxpayers, the flexibility to implement a comprehensive, equitable solution to the credit crunch in the student loan capital markets.
Sallie Mae supports the efforts of Congress and the Administration and is encouraged by this step in the right direction for America’s students and families.
The legislation represents the first step and now the design of program details and implementation are in the hands of the Department of Education. Over the past several weeks, Sallie Mae has delivered a clear message about the need for a government solution to solve the liquidity situation facing student loan originators. We are optimistic that the Department of Education will detail its plan as expeditiously as the Congress moved this legislation to ensure students and families avoid disruptions that could impact college enrollment for the upcoming academic year.