Prospects for Federal Student Loans Improve

The Department of Education and Department of the Treasury appear to have helped ease fears of an immediate crisis around the availability of federal student loans though a deal on implementing the newly passed emergency legislation on student loans. Immediately after the plan was announced, several large lenders, including Sallie Mae, announced they would stay in the federal student loan program - at least for the time being. This positive move by the federal government is an encouraging sign, after the grave concerns about student access to FFELP loans this past winter and spring.

As capital markets dried up, and a steady stream of lenders limited or discontinued FFELP participation earlier this year, Congress passed H.R. 5715, "Ensuring Continued Access to Student Loans Act of 2008." The bill made several changes to the Higher Education Act (HEA) to ensure that students would be able to get federal loans this year (see WIR, 5/12/08). These included providing legal authority to the Department of Education to purchase lenders' student loans for the 2008-09 academic year.

Although Treasury Secretary Henry Paulson had rejected providing FFELP lenders with direct access to federal funding, he supported the agreement which has the Department of Education functioning like a "middle-man." The two secretaries issued a letter on May 21 outlining their plan "to make sure students have access to federal student loans in the coming academic year." The four-part plan includes:

1. A commitment both to purchase new loans from FFELP lenders at a price that will ensure they recoup their investments, and to provide short-term liquidity through Department of Education purchases of participation interests in pools of FFELP loans.
2. A commitment to continue working with lenders to re-engage capital markets.
3. Strengthening of the lender-of-last-resort program.
4. Increased Direct Loan capacity.

The Department of Education will publish the specifics of the terms and conditions under which it will purchase FFELP loans. Lenders would have the option of selling loans made for the 2008-09 academic year until September 30, 2009. Loans sold to the department will be serviced by the department.

For those lenders who don't have the capital ready to lend, the Department of Education has set up a system that conforms to its new authority to buy FFELP loans, but functions more like a somewhat complicated lending mechanism. In short, FFELP lenders obtain outside, short-term capital (a loan), based on an agreement that the department would buy the FFELP loan. Once the FFELP loan is disbursed, the department buys it from the lender, and holds it in trust for one year. FFELP lenders then pay off the original outside loan, and also pay interest to the department on the internal "loan" it is holding. The rate would be commercial paper plus 50 basis points.

Banker reaction to the FFELP portion of the plan has been mixed. Some, like Sallie Mae and Northstar, have reacted positively and have stated that they are committed to staying in or returning to the FFEL program. Others remained cautious, and are doing more analysis before making their decisions. Still others have dropped out of the program, despite the departmental initiative, citing inadequate remuneration from student loans.

For more information, please contact:
Maureen Budetti