Figuring out how to finance a college education is a notoriously confusing and frustrating process. It is not always clear to borrowers exactly how much a loan will cost once it is approved, how much of the debt should be repaid before graduation or how to effectively manage and repay the thousands of dollars owed after graduation.
Now it is the higher education finance industry's turn to be confused. Highly publicized initiatives to temper the preferred lender relationships between universities and loan providers resulted in passage of the House's Student Loan Sunshine Act in May. In late July, while the Senate proposed amendments to the Higher Education Act, U.S. Sen. Byron Dorgan (D-ND) proposed creating a national clearinghouse of data on student loans, allowing potential borrowers to search for the best products in one place.
Meanwhile, the Department of Education tapped on the shoulders of universities, urging them to support a more transparent process by which students can prospect for the most affordable financing. These policies suggest that the federal government wants to see the student lending industry operate in a more open and competitive way.
Why then, are both legislative houses pursuing reductions to the special allowance payments and FFELP reimbursement guarantees that could arguably put an entire swath of operators out of business and reduce healthy competition in student lending?
In mid-July, both houses passed legislation that would reduce special allowance payments (SAP) rates. The House plan calls for SAP to be reduced by 55 basis points for Stafford and consolidation loans, while SAP for PLUS loans would be cut by 85 basis points. In the Senate, lenders would see reductions of 50 basis points for Stafford and consolidation loans, while reducing SAP for PLUS loans by 80 basis points. The Senate bill includes a not-for-profit clause that limits reductions of between 35 basis points 65 basis points, according to a breakdown from Fitch Ratings.
Other proposed changes involve reductions in FFELP guarantees provided to lenders. The House calls for a reduction from 97% to 95%, while the Senate proposes keeping the guarantee level at 97%.
Fitch Ratings said it expects the reductions to affect credit enhancement levels for future transactions that finance increasingly higher percentages of loans disbursed after their designated cutoff dates. Both forms of legislation call for rates to be reduced for loans disbursed on or after Oct.1, 2007.
If the proposed reductions in reimbursement guarantees provided by FFELP guarantors survive the reconciliation process, then the market could see an increase in loan-loss severity. Market observers, however, expect that effect to be mitigated by whatever excess spread the notes generate from future deals.
Granted, none of these changes are expected to alter the outlook of the SLABS market to the extent that issuance drops off considerably. Yet the House and the Senate should understand that their policies threaten to undermine - not promote - a more competitive and open student lending business.
"We're still going to have a market, but it will look different," said one market player. "The middle tier pack of lenders will exit the business."
On the surface, this makes no sense.
More pointedly, it earns Washington, D.C. a pronouncement that shoots around the ASR newsroom whenever a bad idea is put into motion:
"This is why you have no friends."
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