Credit Crunch Pressuring Student Loan Market

With the credit crunch likely to grind on for some time Washington is dusting off a lender-of-last-resort plan to provide for an uninterrupted supply of government-subsidized student loans.

CNBC.com

Concerns have mounted about the impact on the multi-billion dollar student loan market as a number of lenders have recently tightened terms, redlined certain institutions or simply bowed out of the market altogether. The issue may flare brighter going into the peak time for loan origination in July and August.

US Education Secretary Margaret Spellings told Congress recently that her department was closely monitoring the situation but that so far it was aware of no eligible students being denied loans.

“We also understand that credit markets are under stress and conditions may change rapidly,” she told a hearing of the House Education and Labor Committee on March 14.

The lender of last resort plan, which the government last considered deploying in 1998 has never been used, would designate 35 guaranty agencies as a nation-wide network of student loans providers to replace private lenders.

These guaranty agencies are state entities or non-profits that are already involved in administering the Federal Family Education Loan Program (FFELP), by mediating between schools and borrowers, which accounts for 80 percent of all federal student loans.

This program has an outstanding loan portfolio of more than $400 billion, according to Terry Muilenburg, senior vice-president of government and industry relations for United Student Aid Funds, one of the 35 agencies.

Double Trouble

The government plan comes as lenders are being squeezed by both the rising cost of funds and cuts in the yields they are allowed to earn from the federally-guaranteed loans.

The higher borrowing costs are affecting some $150 billion of loans, according to Paul Wozniak, a managing director of UBS Securities.

“The burden on this marketplace is significant and is unlikely to correct itself to avoid having an impact on access to loans,” he told the Congressional committee.

Worries about a flight of lenders from the market spiked after the Pennsylvania Higher Education Assistance Agency announced late last month it was withdrawing from the market, following similar moves by a Michigan agency and the College Loan Corporation.

At the same time, government subsidies offered to private lenders to induce them into the credit-risky student loan market have been cut.

The most recent cut, implemented last fall, trimmed yields 55 basis points to 2.39 percent above 90-day commercial paper rates, according to Harrison Wadsworth, a representative of the Consumer Bankers Association.

The cuts have led some bankers to believe that the private sector is being effectively being pushed out of the market.

To date though there has not been a stampede form the market – partly reflecting difficult prospects in other lending markets --and there are still some 2,000 lenders in the market.

Some banks, including JPMorgan Chase and My Rich Uncle , have actually expanded their lending programs.

Lenders And Borrowers

Thus, for the time being, the sense of crisis is currently more acute for lenders than borrowers,  says Michael Danneberg, education policy director at the New American Foundation, who emphasizes the importance of not exaggerating the fallout for students.

“The danger is that students will wrongly believe they can’t get a college loan because of the credit crunch and therefore shouldn’t apply for financial aid or even to college,” he said. “That’s wrong and would be terrible – panic is the enemy.”

The credit restrictions already having some impact on higher risk trade schools, attended by lower-income and immigrants students, but this could spread, warns Tom Parker of the Institute of Higher Education Policy.

Particularly vulnerable, he says, are expensive four-year liberal arts colleges whose financial aid is already stretched to its limit.

Under the government’s lender-of-last-resort plan, the guaranty agencies would add to their current menu of duties and earn a fee – in lieu of traditional interest payments - determined by the education department.

The education department also has the authority to advance funds if the participating agencies have difficulty raising capital themselves and it insures the loans 100 percent.

But because of the all the potential hiccups ramping up such a complex program, Congress has been urging the education department to accelerate preparations.

”The Secretary [of education] has the responsibility to make sure that these plans have been road tested and are ready to go – if needed,” said US Rep. George Miller (D-CA), chairman of the House Education and Labor Committee after the mid-March hearings.

© 2009 CNBC.com