A Gloomy Projection on Lender Profits

Student loan industry experts consider implications for future in the wake of massive cuts to federal subsidies.
December 7, 2007

Meeting toward the end of what Michael C. McFarlane, chairman of the Consumer Bankers Association’s Education Funding Committee, called the most challenging year for the student loan industry since 1993, bankers on Thursday presented gloomy analyses of the impact of this year's Congressional cuts and weak market conditions on lender profits.

To pay for Pell Grant increases and interest rate reductions, Congress slashed $22 billion in federal subsidies for student loan providers over a five-year period this fall as part of the College Cost Reduction and Access Act -- “unreasonable budget cuts” in lenders’ eyes that left “an industry scrambling,” as McFarlane, the senior vice president for education finance at Citizens Bank, put it.

Lenders have cried that the sky is falling before, that cuts to profit margins would render insolvent the Federal Family Education Loan Program, in which lenders provide federally guaranteed loans to students. And, given the huge profitability of the student loan industry in recent years, it’s only fair to offer the caveat that members of the public and of Congress alike often view the lenders’ arguments with skepticism. With that said, at a session during the Consumer Bankers Association's student lending conference in Arlington, Va., Thursday, education finance experts presented analyses in which, given the new fiscal climate, profits go south, even into the red.

In a presentation on the impact of recent legislation on guarantors, P. Gregory Stringer, senior vice president at Great Lakes Educational Loan Services, Inc., began by briefly outlining recent reductions, stemming from the 2006 and 2007 Congressional cycles, to various streams of operating revenue. As one example, the post-default collections retention fee, or the proportion that guarantee agencies can keep of funds collected from borrowers who default on loans, will fall in fiscal year 2008 from 23 to 16 percent.

Although Stringer cautioned that guarantors can have other non-operating revenue streams as well -- like investment income -- he presented an analysis in which, based on these cuts, a hypothetical guarantee agency's net (operating revenue) income falls from 15 percent in 2006, to 8 percent in 2007, to -9 percent in 2008, and up to -7 percent in 2009. “Essentially what you’re seeing here are revenues coming down pretty significantly" before they start to build back up, Stringer said.

Mark Weadick, managing director of Citi Markets and Banking, followed up on that presentation by demonstrating not only the effect of Congressional cuts, but also of weakening capital market conditions. Take a consolidation loan that before this year’s round of cuts would have generated a 5.5 percent profit for the lender over its lifetime.

Weadick said Washington’s actions immediately cut the profitability of that loan by about half, to 2.8 percent for nonprofit lenders and 2 percent for for-profit lenders. (Among the provisions of the budget reconciliation law was a measure that would set different federal subsidy levels for non- and for-profit lenders). But then, given current securitization market conditions, the value falls by another approximately 2 percent in Weadick's analysis -- making FFEL loans just marginally profitable. (Securitization refers to a process of compiling financial assets and selling them to investors.)

Panelists predicted that, given market conditions and federal reductions to subsidies, cuts to borrower benefits would follow, and to some degree, cushion, the falling profit margins. Stringer projected that guarantors might also decrease waivers of default fees, cut back on their support of community activities and increase their reliance on non-operating revenues.

But there is some room for optimism from the industry perspective despite the difficult straits. The decreased cost to the federal government of operating the FFEL program -- which, given the recent reductions, will cost the government less per loan to operate than the direct loan program in the future, as new federal numbers circulated by lenders suggest -- could sap strength from the argument that direct lending should replace FFEL entirely, as McFarlane said in his opening remarks. And, as for a projection that several speakers alluded to, with the cost of college expected to keep rising, the same can be said of student loan volume in the years to come.


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