"The cost of tuition keeps rising at a faster rate than income or inflation," said Claire Mezzanotte, managing director at Fitch Ratings.
While students may struggle, the student loan ABS market thrives, achieving record issuance of $73.3 billion in 2005.
"We are predicting overall SLABS growth of 5% this year," said Mike Binz, managing director at Standard & Poor's.
The Higher Education Act is likely to play its own modest part in helping to keep volumes steady. The HEA, narrowly passed by the Senate in December 2005 and by the House of Representatives on Feb. 1, awaits the President's signature.
What has changed
The HEA bill, once signed, will alter the loan process on several levels, including: fixed interest rates; increased limits; and decreased insurance. Both Stafford and PLUS loans, the two types covered by the Federal Family Education Loan Program, will be affected.
The most significant change to the FFELP is that loans issued after June 30, 2006, will be at fixed, rather than floating, rates. Stafford rates have floated at 91-day T bills plus 1.7% (for school, grace or deferment periods), and PLUS loans at 91-day T bills plus 3.1%. After July 1, Staffords will be fixed at 6.8% and PLUS loans at 8.5%.
"More important, Stafford borrowers had the ability to convert these floating-rate payments to fixed-rate by consolidating their loans," said David Covey, research analyst at Lehman Brothers.
Until July, when students consolidate, the new loan will be fixed at the weighted average of all the floating loans they are amalgamating.
Also, loan limits are higher following a long flat stretch.
"The last time that happened was 1986 for first-year students and 1992 for second years," Mezzanotte said.
Annual Stafford limits will increase from $2,625 to $3,500 for freshmen, and from $3,500 to $4,500 for sophomores, though the undergraduate aggregate remains unchanged at $23,000. Annual graduate limits also increase, from $10,000 to $12,000. There will be no limits for PLUS loans, now open to graduate students and their parents.
"That was the most surprising aspect of the legislation. It really came out of left field," Binz said.
Insurance coverage will decrease slightly, from 98% to 97%, or from 100% to 99% for servicers designated as "exceptional performers." The impact of one percent should be minimal, according to JPMorgan Securities research analyst Ryan Asato. He noted that, "although the default rate is high for student loans, recoveries are high as well. Student loans are also rarely dischargeable at bankruptcy, unless the borrower can establish substantial hardship."
Some consolidation incentive of switching from floating to fixed has clearly been removed. But being able to extend terms, even up to 30 years for those with high balances, will still motivate consolidators. Consolidations will probably stabilize and become less volatile going forward.
"We still expect students to consolidate, however, since doing so enables a borrower to lengthen the repayment period, thereby lowering monthly payments," said Lehman Brothers research analyst Brian Zola.
When interest rates increased, consolidations and prepayments typically swelled as borrowers hurried to lock in lower weighted averages. We may see a final consolidation spike just before the rules change in July, as students scramble to fix their rates at weighted averages. If rates head south again, "students might even prepay with proceeds from other loans, such as mortgages," Asato said.
One victim of the HEA law may be the private lending side.
"While the private market has grown, most students already turn to the FFELP first," Mezzanotte said.
Private loans, which lack federal guaranties or subsidies, have historically plugged a funding gap for students who needed additional cash.
"Graduates' ability to take out PLUS loans in unlimited amounts will give them an incentive to jump on them," Binz said.
PLUS in play
Graduates who would previously have tapped the private market may now opt for the PLUS alternative.
"It could change the mix, rather than the total volume," Binz said.
Some private lenders may lose customers. Larger providers, such as Sallie Mae, KeyBank and NorthStar, which offer both federal and private loans, might give up some yield in the private market. Private lenders, like First Marblehead, that are geared to undergraduates should not see borrowers desert.
Covey and Zola mentioned a possible benefit for private lenders. In low-rate environments, they said, higher quality borrowers tend to obtain better private rates while worse credits opt for PLUS loans.
As for the small reduction in insurance reimbursement, it could slightly affect credit enhancement, "particularly at the lower end of the spectrum, and on beginning parity levels," Binz said.
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