A Shaky Season for Student Loans

(page 2 of 2)

While the subprime crisis has created the most news, student lenders are also facing fallout from legislation passed by Congress last fall that eliminated nearly $19 billion worth of federal subsidies to student lenders. The combination of these two developments has made for a challenging financial environment for student loan operators, says Mark Kantrowitz, publisher of FinAid, an online provider of student aid information. "The joke in the industry is that Congress took away half the profits, and the asset-based securities markets took away the other half," Kantrowitz says.

The $85-billion student loan industry is often criticized because of the large profits private students lenders make off of students by charging them high interest and origination fees. The legislation was propelled by student borrowers who wanted to see the subsidies issued to private lenders channeled back to federal student loans. As a result of the legislation, an additional $11 billion in federal aid is now available to students.

Financial aid officers are predicting that student loan applicants may find the process more daunting and complicated than in years past. As with the mortgage market, many private student loans are packaged and sold to investors as asset-based securities, leaving them vulnerable to aftershocks of the subprime credit crisis. For example, FinAid's Kantrowitz predicts that many companies will no longer issue loans to students with credit scores below 650 to protect themselves from any subprime exposure. In addition, loan companies will require more applicants to have co-signers. "I do expect it to be a little more difficult to get one of these private loans," Kantrowitz says.

Are Lenders Hurting?

Borrowers' worries extend even to the largest student loan lender, SallieMae (SLM), which is also cutting back on federal loans and concentrating more on the private market. Earlier this month, the company said in a Securities & Exchange Commission filing that in response to the financial environment, it would be "more selective" in making federal and private education loans. Since then the company has reassured institutional borrowers that it is in sound financial condition, according to a Jan. 17 report in the Chronicle of Higher Education.

The decision by some companies to withdraw from the federal loan program could indicate that more lenders are hurting, said John Dean, special counsel to the Consumer Bankers Assn., an Arlington (Va.) group that represents bank lenders in the student loan programs. "This is significant because National Education and Goal Financial were well-known operations and were seen a couple of years ago as growing rapidly," Dean says. "We presume that if they are experiencing difficulty that others could be experiencing difficulty as well."

Representatives from National Education and Goal Financial declined to comment on the federal loan suspensions. Next Student did not return phone calls requesting comment.

Private loan companies' investment practices may have led to some "overexuberance" on the part of private lenders, says Robert Shireman, executive director of the Project on Student Debt, a group that focuses on student financial aid. Like Kantrowitz, he expects private loan companies to be more cautious when making loans to students.

Battered Family Finances

In the meantime, financial aid officers are sitting back and anxiously waiting to see how the student lender landscape will shift if more loan companies continue to pull out of segments of the market.

Bill Witbrodt, director of student financial aid services at Washington University in St. Louis, says he has not seen students directly affected yet, but expects that could change. Plus, battered family finances could send more students into aid offices. Right now, students aren't reporting family financial stress from the credit crisis, Witbrodt says. "If this continues, I would expect it [to] and, in fact, I'm surprised it hasn't already."

Students facing the greatest difficulty in obtaining private loans are international graduate students, who are not eligible for any of the federal loan programs, says Rockne Bergman, manager of graduate and professional programs at University of Minnesota's financial aid office. He counsels international students seeking loans from the law, business, and nursing schools, among others, and says he has already seen the market tighten for them.

"These lenders are just being very careful as to whom they are lending to. And they want to make sure they will be able to get those loans paid back," Bergman says.

Financial aid officers like Eckerd College's Watkins say their greatest fear is that the lending environment will create a situation where students strapped for cash will take out risky private loans with sky-high interest rates, no matter what the cost. For example, Watkins says she has seen commercials on TV aimed at students with poor credit ratings and promising no interest or payment until graduation. Those loans tend to come with higher origination fees and higher, unpredictable interest rates that compound the amount students owe after graduation into a "significantly higher amount," Watkins says: "We haven't seen the full impact of this yet, but it is coming."

Damast is a reporter for BusinessWeek.com.