WASHINGTON — Legislation introduced by a key House lawmaker to require all federally guaranteed student loans to be issued directly by the federal government includes provisions that may impact the market for existing debt backed by student loans, market participants said yesterday.
The legislation, which was introduced Wednesday by Rep. George Miller, D-Calif., chairman of the House Education and Labor Committee, would eliminate the Federal Family Education Loan, or FFEL program, building upon President Obama’s fiscal 2010 budget proposal.
But the bill, which is expected to be voted on by committee members Tuesday, would preserve a role for some of the existing FFEL lenders, including state-level nonprofits that issue municipal debt, by allowing them to service direct federal loans.
At least two provisions in the bill may have implications for the existing market of debt backed by student loans, according to the muni market participants.
One provision would allow lenders, beginning Jan. 1, 2010, to select an alternative index — based on the one-month London Interbank Offered Rate — to be used to determine the subsidy rates for their loans. The Libor-based index would replace a commercial paper-based index that has caused problems for lenders during the past year.
The other provision would allow borrowers to reconsolidate their FFEL loans into consolidated direct loans, which could increase the amount of prepayments on existing FFEL loans, sources predicted.
The provision allowing lenders to switch to a Libor-based index comes amid tremendous federal intervention since late last year that has caused the CP index that loan subsidies have been based on to fall out of kilter from the rates lenders must pay to finance their loans, which typically are based on Libor, one student loan lender official said. Specifically, CP rates have been extremely low during the past three quarters because of Fed guarantees designed to prop up the CP market, the official said.
If lenders elect to adopt Libor-based formulas, the switch may require bondholder approval if it is deemed to be a materially different value than the CP-based index, according to market participants.
Meanwhile, prepayments of existing FFEL loans may increase under the consolidation provision, said Paul Wozniak, chairman of San Diego-based College Loan Corp., who added it is not clear how many borrowers would take advantage of the opportunity, because it is not yet clear if they would benefit from a lower rate by switching. The consolidation provision would not take affect until after June 30, 2010.
If there is a benefit and borrowers opt to consolidate into the direct loan program, the switch could bring in cash to the trusts of the existing FFEL loans, leading to the redemption of, among other things, some auction-rate securities that remain illiquid, he said.