Three of the largest nonprofit student loan lenders have temporarily withdrawn from lending in the federal family education loan program despite a high-profile plan by the Department of Education (DOE) designed to assist non-bank lenders in financing student loans.
Brazos Higher Education Service Corp., NorthStar Education Finance, and the Pennsylvania Higher Education Assistance Agency (PHEAA), historically some of the largest issuers or obligors of tax-exempt debt backed by student loans, have suspended their FFELP lending because they cannot secure crucial "bridge loans" that they need to participate in a new, short-term liquidity program run by the Department of Education, their officials said.
Under the program, the DOE would provide liquidity to FFELP lenders, but only after they have obtained bridge loans elsewhere, because the department does not believe it has the authority to provide money to lenders that haven't already originated loans. A bill rushed into law in early May authorizes the DOE to provide liquidity to FFELP lenders and to also purchase the loans through September 2009 if lenders remain unable to issue debt backed by the loans they originate.
But Murray Watson, president and chief executive officer of Brazos, which announced in late July that it was temporarily suspending lending in the FFELP program, said, "We have simply run out of time to secure financing to disburse loans as soon as they are needed."
NorthStar and PHEAA followed last week. All told, over 120 FFELP lenders both for-profit and not-for-profit, have curtailed their participation in the program, according to Finaid.org, which provides information on the student loan market.
Specifically, DOE officials told lenders that once they tapped a line of credit and received bridge financing, the lenders could disburse their student loans, after which they would be eligible to borrow funds through the department once a week, via a "custodian."
Each week, the lenders would have to provide the custodian with a roster of loans they originated and the department would give the lender the money to fund those loans within seven to 10 business days. The lenders would then use the funds they borrowed from the department to pay back their bridge loans.
But details of the program many of them technical remain unresolved and lenders say they have not had enough time to find any bridge lender comfortable with it.
Jamie Wolfe, chief financial officer for St. Paul-based NorthStar, one of the largest lenders that caters to graduate students, emphasized that the setback is only temporary.
"We're still confident that we'll fund loan disbursements, hopefully by late August," he said. "Right now our message is if you need money today, you're going to have to go elsewhere. But if you can wait a couple of weeks, keep sending us loan applications."
The suspensions in the federal loan program comes as FFELP lenders have been squeezed by congressionally mandated cuts in the interest they can earn on their loans, combined with the ongoing credit crunch that has dramatically increased their borrowing costs to the point where it has become prohibitively expensive for many to issue new debt.
For instance, the spread between London Interbank Offered Rate and the interest rate on a seven-year floating-rate student loan bond increased from 90 to 95 basis points in July to 155 to 160 basis points in August, according to pricing data supplied by Wolfe.
The only FFELP lender to publicly announce that it would be able to participate in the DOE liquidity program is Delaware-based Access Group, which has an existing relationship with a group of banks that already provide short-term lending for its loan program.
Access Group president and chief executive officer Christopher Chapman projects the firm will originate between $1.2 billion and $1.5 billion of FFELP loans this academic year, but noted that it would have a difficult time if it did not have an existing line of credit with the group of banks, which he declined to identify by name.
"If we didn't have this relationship, I'm not sure how easy it would be to create one in this environment," Chapman said. "I expect it's some tough sledding getting banks comfortable with the new federal program and how it works since it's not up and running, yet."
Meanwhile, Tom Deutsch, deputy executive director of the American Securitization Forum, an affiliate of the Securities Industry and Financial Markets Association, said that banks will have to be cautious in weighing whether to provide bridge lending because the DOE liquidity program is new. Among other things, he said, banks will have to perform due diligence to make sure the student loan lenders meet the department's eligibility requirements, which could take time.
Samara Yudof, a DOE spokesman, said in a statement that the department remains committed to working with the student lending community to ensure that "FFELP and other student lending programs serve the best interest of students and taxpayers."
"Based on our ongoing correspondence with the FFEL community, to date we are not aware of any schools that have had a problem finding alternative FFEL lenders for the 2008-09 school year for their students," she said.
But Wolfe highlighted a number of concerns raised among bridge lenders, among them the lag between they day they originate a bridge loan and receive repayment from the lender. The department has promised that lenders will receive their money within seven to 10 days of filing with the custodian, but lenders would like a quicker turnaround and specific date for it.
Another issue is the security of the put option on the loans - in which the DOE agrees to buy back until next September any loans originated this academic year. Specifically, potential bridge lenders are concerned that they would be open to a large exposure in the event that they made a bridge loan to a lender that subsequently went out of business before it could securitize its loans or sell them back to the department.
"If there's any kind of problem with the student lender let's say they're struck by lightning the banks want to immediately sell the loans to the department so that they get reimbursed," said one lender official who asked not to be named. "They want to be damn sure that they can put them to the department."
Yet another concern revolves around so-called negative special allowance payments, the quarterly payments lenders must make to the department on the difference between the interest rate a student receives on a loan and the rate a lender is allowed to receive under federal law.
Students may receive a 6.8% rate on their loans, but federal law currently limits what lenders can earn to a rate that is much lower and based on variable commercial paper rates. By law, lenders must rebate the difference back to the DOE in cash on a quarterly basis, but many would like to defer such payments until they put the loans to the department, when the SAP payments could be netted out of the price the lenders receive for their loans.
Yudof said the department is not able to allow for the deferral of SAP payments because the law says lenders must make cash payment when they are due.