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Student Loan Law Has Lenders Wondering

WASHINGTON  — President Obama’s enactment of a new law yesterday that would require all federally guaranteed student loans to be originated by the federal government has led the state and nonprofit entities that have historically loaned to students to contemplate their future in the market.

Some of these entities, which have been major issuers of student-loan backed municipal bonds, were considering recasting themselves as “private” lenders or as servicers of the federal loans.

In a speech prior to signing the legislation, which cleared Congress last week attached to the massive health care reform package, Obama hailed the lending reforms as a way to save $60 billion in reduced borrowing costs that can be plowed into additional grants for students.

Specifically, the legislation eliminates the Federal Family Education Loan, or FFEL, program, and requires all new federally-backed loans to be originated through the Ford Federal Direct Loan program beginning July 1.

Though FFEL lenders opposed the measure, student-loan lenders or their trade groups said yesterday that they will continue to have a role in student lending, possibly through new or expanded private lending programs in which they originate student loans that are not federally guaranteed.

Private loan demand is greatest in the Northeast, where there is a high concentration of expensive private colleges and universities, said Peter Warren, president of the Education Finance Council, which represents nonprofit state-level agencies.

Kenneth Roberts, a partner at Hawkins Delafield & Wood in New York, said there is likely to be a significant role for private lenders to supplement the federal direct lending program, which caps the amount of loans an individual student can receive each year and over the course of his or her academic career.

“Based on the law that just passed, there will be a good amount of unmet need in the sense that the aggregate cost of attendance will exceed availability” of direct loans, Roberts said. “Longer term, there’s a very good likelihood that the federal government will not fully fund the cost of attendance.”

States may continue to make private-activity bond volume capacity available for student loans if there is a lot of unmet need, allowing state-level borrowers to sell tax-exempt bonds backed by their private loans, Roberts said. However the underlying loans would not be federally guaranteed as they have been in the past.

But an official at one large state-level agency, who did not want to be named, said while his agency is planning to originate a significant volume of private loans, there are several liquidity issues that must be resolved before the agency can ramp up its program.

The official said his agency is still grappling with a large portfolio of illiquid auction-rate securities. The EFC estimates that the bulk of the roughly $75 billion of outstanding student loan debt that has been sold by nonprofits consists mostly of ARS, though no precise estimate is publicly available.  The official also said it is still difficult for large lenders to raise capital at affordable rates, as many large banks and financial institutions “are not in the mood right now to lend large sums of money.”

“We think the market’s healing, but it’s healing slowly,” he said, adding that lenders’ ability to “borrow and turn it around to students” has not fully returned.

While it is unclear  to what extent nonprofits would serve as private lenders, Warren noted that nonprofits are eligible to contract with the Education Department to service the direct federal loans under a provision included in the new law that was championed by EFC.

Under the provision, EFC’s roughly 35 members are eligible to join the four existing servicers of direct loans. Specifically, each of the members are eligible to service the loans of up to 100,000 students, with discretion given to the secretary of education to subsequently adjust the levels.

“We’re going to have to see how that provision is implemented and we’re hopeful that there’s going to be a lot of nonprofits that are going to have a significant line of business servicing federal loans,” the official said.

In a conference call with reporters yesterday, Education Secretary Arne Duncan acknowledged that while the federal government would originate all future federal student loans, 100% of the loans would be serviced by private sector firms, giving them the opportunity to grow their businesses in “significant ways.”

Duncan did not say when the department would contract with these additional nonprofits, but a spokesman for the agency said that it currently has sufficient servicing capacity to accommodate new direct loan borrowers. Currently, only one existing nonprofit lender, the Pennsylvania Higher Education Assistance Agency, has contracted with the department as a servicer.

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