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Student Loans and the Credit Crunch

May 22, 2008

When discussing the impact of the "credit crunch" on the student loan program, it is important to differentiate between two distinct types of student loans:

federally-guaranteed loans; and
alternative, or private, loans

Federally-guaranteed loans are made through two federal programs -- the Federal Family Education Loan (FFEL) program and the Direct Loan (DL) program. Campuses determine which program to participate in, but are able to participate in both. Typically, campuses that participate in both programs utilize one program for undergraduates and the other for graduate students.

  • In the FFEL program, lenders provide the capital to make loans to students and families. These loans are guaranteed by the federal government in case of default. The Higher Education Act (HEA) sets certain terms and conditions of the loans (interest rate, repayment periods, default and forbearance requirements, and maximum annual and cumulative loan limits). For the most part, loans made through the FFEL program are not credit-based and are available to students regardless of their credit history. The one exception to that rule is the parent PLUS loan and the Grad PLUS loan. These loans are credit-based. While there are over 2,000 lenders in the FFEL program, most of the loans are made by the top 25 lenders. This means that actions taken by the largest lenders will have a disproportionate effect on the overall student loan market. For FY 06, the top 25 lenders originated over 72 percent of the nation’s volume. Lenders participating in the FFEL program affiliate with state or non-profit corporations known as guaranty agencies, who insure loans against default.
  • In the DL program, the Department of Education (ED) serves as the lender and the funds come directly from the U.S. Treasury. ED contracts with a third party for the servicing of Direct Loans. Currently, only about 20 percent of total loan volume is made through the DL program.

The private loan market is comprised of lenders who provide credit-based consumer loans to borrowers who qualify and meet the terms and conditions set forth by the individual lender. These loans are not guaranteed by the federal government, but are governed by the same laws and regulations as other consumer loan products. ED does not have any jurisdiction or authority over private loans, though the House-passed version of HEA proposed giving ED some oversight responsibilities over these loans. Lenders that participate in the federal program may also offer private loans.

As part of the FY2009 budgeting process, the House and Senate passed a bill which made a number of changes to the federal loan programs. Interest rates for students will decline, and significant cuts were made to subsidies paid by the federal government to FFEL lenders. In addition, further statutory changes to the program are being considered as part of the HEA reauthorization currently in conference negotiations on Capitol Hill.

Who’s Who?

Not-for-profit lenders and state-based student loan secondary market organizations (e.g., Access Group, Student Assistance Foundation, Arkansas Student Loan Authority) and non-traditional lenders (e.g., Sallie Mae, Nelnet) use a variety of strategies to raise capital in the marketplace, which is, in turn, offered as student loans. All of these types of organizations may participate in both the FFEL program and the private loan market, with varying levels of participation by each affiliated organization.

Many traditional deposit banks (e.g., Chase, Bank of America, Wachovia, Citibank) participate in the FFEL program and offer private loans. These financial institutions may not need to utilize capital markets because their banking operations are generally their source of capital to lend out to student borrowers. However, deposit banks do sell their loans to the not-for-profit lenders on the secondary market. In FY 06, traditional banks held nearly 24 percent of outstanding volume while non-banks held over 76 percent of volume. In selling the loans to the secondary market, banks free up their capital and are able to make additional loans to students. Many of the not-for-profit lenders also buy loans from the banks on the secondary markets, which means that if the not-for-profit lenders are facing a short-term liquidity problem, the banks may face a long-term liquidity problem when the secondary market is not available to buy their loans.

Activities & Actions to Date

The reaction to the subprime mortgage crisis has, for some lenders participating in the FFEL program and the private loan market, made it more difficult to securitize existing loan portfolios. As a result, these lenders are without access to the capital they need to actually make new loans to students.

Some may argue that the markets will right themselves and that the current credit crunch is a natural ebb and flow for the market. However, many experts suggest that is not the case. For example, while the auction market has experienced higher rates in the past, there have never been failed auctions--where there are no buyers to purchase the loans. At the onset of the crisis, some not-for-profit lenders had failed auction transactions, which translated to the inability of these lenders to access the capital needed to originate new loans.

As of May 22, 2008:

  • Eighty-nine education lenders have exited or suspended their participation in all or part of the FFEL program. Seventy-two lenders have suspended participation in the entire FFEL program, 17 lenders have suspended participation in the consolidation loan program only, and 26 lenders have suspended their private student loan programs. Since early 2008, a total of 94 unduplicated lenders have suspended federal and/or private loan programs.
  • Four non-nonprofit state loan agencies--Pennsylvania Higher Education Assistance Agency (PHEAA), Massachusetts Education Financing Authority (MEFA), Michigan Higher Education Student Loan Authority (MHESLA) and Brazos (TX) have suspended all FFEL program originations. NorthStar Guarantee had suspended all activity in the FFEL program, but has subsequently resumed making Stafford and PLUS loans, but not consolidation loans.
  • The lenders who have exited all or part of the FFEL program account for over 12 percent of Stafford and PLUS loan origination volume and 83 percent of FFEL consolidation loan volume. These lenders originated more than $7 billion in Stafford and PLUS loans and more than $39.3 billion in consolidation loans in FY 07.
  • All of the top ten and 38 of the top 100 consolidation lenders have stopped making consolidation loans, and 27 of the top 100 originators have stopped making Stafford and PLUS loans.
  • In addition, a number of institutions are reporting anecdotately on email lists that some FFEL lenders have informed them that they will no longer offer loans to the institution's students, usually because the volume of loans from that college or university is too low.

There are 5,966 institutions of higher education eligible to participate in the Title IV loan programs. Of that number, 4,105 institutions actively participate in the FFEL program, while 1,150 institutions actively participate in the DL program. However, since February 2008 to today, more than 288 institutions have begun the process to switch to the DL program. This compares with 9 institutions switching during the same time period in 2007. Although there has been concern expressed in the community that the DL program would be unable to handle a sudden shift in loan volume, ED has assured institutions that it should be able to double its loan volume. The process for an institution to switch from the FFEL to the DL program might be difficult to accomplish in a very short period of time if a school were to suddenly determine that its students had difficulty accessing loans.

As a result of these departures and the credit crisis, students may pay more for their loans as lenders scale back or eliminate borrower benefits, such as reduced interest rates, on-time repayment benefits, and reduced fees.

  • To date, there is no evidence that a qualified student has not been able to obtain a loan through the FFEL program.
  • However, 23 (as of 05.02.08) lenders have suspended operations in or left the private loan market. Many lenders have adjusted their criteria so that borrowers with low, fair, or even good FICO scores (a score developed to determine the likelihood of a credit user to pay their bills) may not have access to non-federal loans. This is a natural reaction by many lenders who make credit-based consumer loans. The budget reconciliation bill and the pending HEA reauthorization bill will also dramatically impact lenders’ bottom lines. On top of these statutory changes, the credit markets are almost frozen because of the subprime mortgage crisis. It is important to remember this is not a result of bad credit, but unexpected fallout of the crisis of confidence in the overall capital markets.
  • If borrowers do gain access to these loans, they are paying more in interest and higher fees for the loans than in months and years past.

Over the course of the last few weeks, bipartisan letters have been sent by members of Congress to Secretary of Education Margaret Spellings and Treasury Secretary Henry Paulson asking for them to monitor the impact of the credit markets on the student loan programs. Specifically, members are asking Secretary Spellings 1) what steps she and her department are taking to ensure that the DL program is ready to take additional loan volume if necessary; 2) what the department is doing to ensure that guaranty agencies have lender-of-last-resort plans in place; and 3) to consider taking steps to increase the amount of capital in the markets.

There is some concern by members of Congress and those in the higher education community that while the DL program may be able to support some additional loan volume, it will not be able to manage a shift of significant volume all at once. Current department projections indicate that DL could absorb about 30 percent of total FFEL volume, which equates to doubling the size of the current DL volume. At this time, the DL program is projected to make $15 billion in new loans in FY 09, compared to the $60 billion in the FFEL program for the same time period.

There are 5,966 institutions of higher education eligible to participate in the Title IV loan programs. Of that number, 4,105 institutions actively participate in the FFEL program, while 1,150 institutions actively participate in the DL program. However, between February 2008 and May 6, 2008, more than 100 institutions have begun the process to switch to the DL program. This compares with 9 institutions switching during the same time period in 2007. Given its current size, it is unlikely that the DL program would be able to handle a sudden shift in loan volume. The process for an institution to switch from the FFEL to the DL program would be difficult to accomplish in a very short period of time if a school were to suddenly determine that its students had difficulty accessing loans.

The lender-of-last-resort (LLR) is a proposed solution to the current crisis, but this program directly involves guaranty agencies, not institutions of higher education.

  • Specifically, current law requires guaranty agencies to develop policies and operating procedures to ensure that a borrower in the geographic area serviced by that guaranty agency is able to obtain a loan. The agency can make the loan or direct the borrower to a designated lender.
  • The secretary of education is authorized to advance loan capital to the guaranty agency if it is needed in order to enable the agency to make loans under these provisions.
  • The federal guarantee on these loans is 100 percent, which is three percent higher than what lenders would receive if they made a loan under normal circumstances. Otherwise, the terms and conditions on these loans are the same as loans made under current law.

On March 27, the department issued guidance to guaranty agencies on LLR services in the FFEL program. The original intent of the LLR provisions was to deal with situations when individual students were not able to get loans, rather than to serve as a large scale lending platform. The March 27 letter provides preliminary information on the implementation of an LLR program by a guaranty agency and requires agencies to submit their updated LLR rules and operating procedures to the department within a month.

Tuesday, April 8: The Education Resources Institute (TERI), the oldest and largest non-profit guarantor of private education loans, filed for chapter 11 bankruptcy on April seventh. TERI’s actions were taken as a direct result of the credit crisis and difficulties financing the securitizations of private education loans. TERI will continue its grant and foundation-funded initiatives.

Wednesday, April 23 and Thursday, April 24: Secretary of Education Margaret Spellings, Secretary of the Treasury Henry Paulson Jr., and Office of Management and Budget Director Jim Nussle sent a letter to the Chairman of the Senate Banking, Housing & Urban Affairs Committee, Christopher Dodd (D-CT) regarding the state of the student loan market and steps the Administration is taking to stem the crisis. The Department of Education indicated they are working to make sure the Lender of Last Resort (LLR) program is prepared to handle the necessary volume and that the Direct Loan program has the capacity to absorb additional volume should institutions of higher education choose to participate. However, Treasury Secretary Paulson stated that utilizing the Federal Financing Bank (FFB) is not an option to ensure necessary short-term liquidity is available for student loan originations for the coming school year. The letter said the FFB does not "have the authority under the Federal Credit Reform Act to purchase, or otherwise participate in, loans to non-Federal borrowers in these circumstances." In response, Senator Dodd issued a statement expressing his disappointment with the Administration’s response to his concerns, mainly the lack of detail regarding the Treasury Department’s ability to prevent the student loan crisis from escalating.

Wednesday, April 30: Federal Reserve Board Chairman Ben Bernanke responded to Senator Alexander (R-TN) who wrote to the Chairman regarding the problems in the capital markets, which have impacted student loans. Chairman Bernanke argued that the difficulties faced by lenders in the student loan program are due to a "range of causes," but assured lawmakers that the Federal Reserve is "working to promote the restoration of more-normal conditions across the broad landscape of financial markets."

Friday, May 2: The House and Senate passed versions of H.R. 5715, the Ensuring Continued Access to Student Loans Act of 2008. The bill is expected to be signed by the President in the coming days. The major provisions of the bill include:

  • A clarification of existing law to provide mandatory authority to the Secretary of Education to advance federal funds to guaranty agencies operating as lenders of last resort.
  • Providing the Secretary of Education temporary authority to purchase loans from lenders in the federal loan program, only if such a purchase would have no cost to the federal government.
  • An increase in annual loan limits for federal unsubsidized student loans by $2,000 for undergraduate students;
  • An increase in the aggregate borrowing limit from $23,000 to $31,000 for dependent undergraduates and $57,500 for independent undergraduates; and
  • The ability for parents to defer repayment on federal PLUS (parent) loans until six months after a child’s graduation from college.

On Friday, Chairman Bernanke relented on earlier resistance to allowing the Federal Reserve to backstop student-loan debt the same way it has assisted with mortgage-backed securities. The Fed will now accept student-loan-backed securities as collateral for borrowing under its Term Securities Lending Facility.

Monday, May 5: The Department of Education issued guidelines for implementation of the Lender-of-Last Resort (LLR) program. The letter is intended to specifically address questions of guaranty agencies on issues of LLR program planning and compliance. At a press conference on the issuance of the letter, the Department reaffirmed that officials are not aware of any students who were unable to receive FFEL program loans. Additionally, Department officials indicated that they would be ready to serve in the capacity of Lender of Last Resort by June 1 if market conditions deemed their involvement necessary.

Wednesday, May 21: The Department of Education has released the implementation details of H.R. 5715, the Ensuring Continued Access to Student Loans Act of 2008. In the Dear Colleague letter, the Department discuses the following four steps of its plan to ensure access to student loans:

  1. As authorized by HR 5715, the Department will purchase loans from the FFEL program lenders for the 2008-2009 academic year and offer lenders access to short-term liquidity;
  2. The Department pledges to continue working with the FFEL program community in the short-term to explore programs that might re-engage the capital markets;
  3. The Department will make available, if needed, an enhanced lender-of-last resort program; and
  4. The Department has the capability of doubling the capacity of the Direct Loan program, should it be needed.

Sallie Mae, the nation’s largest originator of federally-guaranteed student loans, announced that they will continue to originate loans following previous reports that the student loan organization might withdraw from the federal program. Sallie Mae originated nearly $9 billion in new federally-guaranteed loans during 2007 and is a household name for students and families who finance higher education studies through the federally-guaranteed program.

Frequently Asked Questions

These questions may be on your mind, or could be questions you ask of your Financial Aid Director and their staff. In summary, a list of available online resources is provided. Additionally, through continual updates, NACUBO will provide you and your campus administration with the most up-to-date information on ways to manage the shifting landscape.

All of this discussion of the credit crisis worries me. I would feel better if my campus left the FFEL program and started offering Direct Loans to students. What does my campus need to do? Making a transition from the FFEL program to the DL program is not as easy as flipping a switch. Not only will students and families be impacted by the transition from one program to another, but the institution may experience cost increases as a result of switching operating systems and training administrative and professional support staff. As of early April, more than 50 institutions have begun preparations to switch to the Direct Loan program.

My school participates in the FFEL program and many of my students’ loans are with College Loan Corporation, PHEEA, Brazos, or one of the other lenders that have left the program. What does my campus need to do to ensure the continuity of financing for students? Lending organizations remain committed to assisting students with financing their education. If your institution is directly involved with one of these lenders, it is best to contact the lending organization directly to determine what products and services remain available to your students. It is prudent to have discussions with other lenders in your area to determine their availability to provide student financing options.

My school offers Direct Loans to undergraduates, but offers loans from the FFEL program to graduate students. Should I be concerned? Qualified borrowers who attend FFEL schools have not been denied a loan through the FFEL program. However, your institution should pay careful attention to the activities and business plans of lenders who make private loans to students. Many times, graduate students rely solely upon the financing available through private loans. The private loan market has already seen an increase in interest rates and tighter eligibility qualifications for borrowers, which are likely to continue. It is important to encourage your students to be their own best advocate and constantly shop around for the best deals.

My institution participates in the Direct Loan program. Will my students’ loans be impacted by the current crisis in the market? Schools which participate solely in the Direct Loan program should not be directly impacted by the "credit crisis." However, students who need private loans, or have obtained PLUS loans, should remain vigilant. If families default on other consumer loans (e.g., credit cards, mortgages), then their PLUS loan eligibility could be impacted.

My institution offers loans through the FFEL program and most loans are made through a not-for-profit lending organization. Given the difficulty for not-for-profit lenders to gain capital from the markets, does my campus run a greater risk of not being able to offer loans to students? Many schools that offer loans to students through the FFEL program and not-for-profit lending organizations are in close contact with their lending partners. The best advice is to remain in contact with your lending organizations, as they are willing to work with schools as this situation continues to unfold. Your students may witness a reduction in borrower benefits; however, this does not mean that the lending partner is unable to make loans. Cuts to lender subsidies by Congress coupled with the current market situation is forcing many lenders to reallocate resources to ensure the availability of loans and high-quality services for borrowers.


WEBCAST: Moving to the Federal Direct Loan Program (recorded on May 20, 2008)

The following online resources provide a wide variety of perspectives on the current situation, and offer guidance and direction for various types of campuses:

NACUBO Contacts

Anne C. Gross
Vice President, Regulatory Affairs

Matt Hamill
Senior Vice President, Advocacy and Issue Analysis