Loan companies forced to freeze funds, downsize due to recent economic collapse, lenders cut back to stay afloat

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Loan companies forced to freeze funds, downsize
Due to recent economic collapse, lenders cut back to stay afloat
By HUSAIN DANISH
Issue date: 2/12/09

The continuing global credit crunch has forced major student-lenders to cut back, with 39 private student loan companies announcing immediate suspensions of student loans, according to Mark Kantrowitz, publisher of the financial aid guide finaid.org.

According to the guide, a total of 177 lenders have suspended either federal or private loan programs.

The Hopkins Office of Financial Aid claims that it is not affected by the current loan market.

"Our only area of potential exposure is in the private/alternative loan market," Director of Student Financial Services Vincent Amoroso said.

"Since these loans are fully funded by lenders, there has been an impact at the national level in availability. However, that has not been the case at Hopkins. Given our academic reputation, high graduation rates and potential earnings for our graduates, lenders are still providing loans to our students," he said.

Amoroso said that Hopkins students were still able to obtain private loans, despite the conditions.

"I don't want to imply this couldn't change in the future, but I do think we would be one of the last schools in the country to see this source of money dry up," he said.

While the credit crunch has not affected federal programs like Pell Grants and Stafford loans, the shrinking student loan market has many worried.

"The private lending industry has become paralyzed," Senior Vice President Johanna Liadis of National Education, one of the many student lender corporations suffering from the economic crisis, said.

"No one wants to go out of business and stop lending. However, some lenders have overstretched and have to close the doors," she said.

Although many of the lending institutions still express a desire to offer private student loans, several institutions, such as Bank of America and Wachovia, have suspended their student loan programs.

Other major lender corporations, including TCF Bank, M&T Bank and HSBC Bank, have ceased their participation in the Federal Family Education Loan Program (FFELP).

According to American Student Assistance (ASA), a non-profit student loan guarantor, the federal lending program is currently stable.

The crisis in the student lending market originated from the collapse of the sub-prime mortgage industry in early 2007.

"It is vital to understand that these lenders are not banks; they need to get their money from somewhere," Kantrowitz said.

Educational lenders use a credit warehouse facility - a short-term loan from a large international bank - to fund student loans. However, these large, short-term loans tend to be expensive.

In order to obtain a cheaper source of capital, lenders securitize their loans, transfer them to a trust and sell shares to investors.

The process provides lenders with the original balance of funds plus a premium, which lenders use to fund student loans and pay for operational expenses. In return, investors are guaranteed some income from the loans.

This system requires a large initial investment by the lender (at least $100 million), favoring larger firms in the process. In order to increase profit, lenders focus on increasing the number of loans.

Educational lenders generated massive profits under this system. In 2006, Sallie Mae, the largest student-lender in the country, originated $16 billion in government-guaranteed loans and an additional $7.4 billion in private loans. The company's return on equity was over 30 percent, one of the highest among American companies.

The success, however, was short-lived. In 2007, Congress passed the College Cost Reduction and Access Act, which reduced the number of subsidies that went to private lenders and re-invested the money in Pell Grants and Stafford Loans.

While a major gain for college students, the Act reduced profit margins for student lenders and forced many corporations to cut back on lending.

The situation was exacerbated in August 2007 when problems in the sub-prime lending market began to spread to the securities market. Investors, weary of the housing market collapse, lost interest in the educational securities market, resulting in decreased liquidity (usable money) in the lending market.

"If lenders can't securitize their funds, they can't make student loans," Kantrowitz said. "If you can't pay off the credit warehouse, the lender has two options: convince the credit warehouse to lend more money or stop making student loans."

Student lenders began to take drastic actions.

Throughout 2008, lenders announced plans to withdraw participation from FFELP.

Several corporations also announced plans either to reduce or completely suspend their private student loan operations.

While no new private loans are being made, most lenders have continued to honor pre-existing student loans.

"National Education has fully funded every loan that it has made a commitment to," Liadis said.

Some lenders have been forced to completely close their operations. MyRichUncle, the exclusive loan partner of Princeton Review, filed for bankruptcy last Monday.

No comment was available from MyRichUncle.

Sallie Mae has also been forced to cope with the problems of the lending market, laying off thousands of employees and closing several offices.

The company has also stopped making recourse loans - sub-prime loans to high-risk students. However, Sallie Mae still participates in FFELP.

"Sallie Mae also continues to provide private loans," Patricia Christel, spokesperson for Sallie Mae, wrote in an e-mail to the News-letter.

"Because of the continued turmoil in the capital markets, we have significantly tightened our credit underwriting criteria under which we provide private loans," she wrote.

"Last year's lending saw higher credit scores and a higher percentage of loans made to students with co-signers."