A year after President Obama signed a law eliminating bank-based student lending, the lenders and guarantors that formed the backbone of the old system have laid off thousands of workers, eliminated programs, and sought out new roles in the student-loan industry.
The Education Department is working to soften the impact with money to help retrain student-aid workers, servicing contracts for nonprofit lenders, and offers to pay loan guarantors to develop default-prevention programs. But those steps may not be enough to prevent further cuts and layoffs.
Students took out some $65-billion in federally subsidized loans through the bank-based system during the last year it was in place, and the lenders are still collecting interest and servicing fees on the loans they made before the law was passed. But without the ability to make new federal loans, they are looking for ways to stay in the market—for example, by offering new credit “products,” some of which combine elements of tuition-installment plans and student loans.
The guarantors, which insured bank-based loans against default, are redefining themselves as loan servicers or providers of financial-aid advice.
Those efforts could bring about innovative ideas for helping people pay for college. But many of the ideas may not work out, which could lead to a further shrinking of the industry.
Subsidies Gone
Until last year’s change, the federal government had paid subsidies to private lenders to provide federally supported student loans through the Federal Family Education Loan program, or FFEL. Lenders participating in the program faced virtually no risk, because guarantee agencies insured most of the loans, and the government reinsured the guarantors.
That system ended when Congress eliminated the program as part of legislation that also overhauled the nation’s health-care system. Under changes that went into effect last July, students seeking federal loans now must borrow directly from the government. The Congressional Budget Office had estimated that the government would save about $87-billion, which would otherwise have gone to the banks in the form of subsidies and administrative fees, over a period of about nine years. The Obama administration said those savings would help pay for increases in Pell Grants, which were expanded last year.
The major student-loan companies started focusing more on providing what’s known as “gap funding"—private loans to help pay costs left uncovered by a student’s federal loans and other financial aid, says John Dean, a lobbyist for the Consumer Bankers Association.
The shift meant that the companies were significantly scaling back their student-lending programs, offering smaller loans to far fewer students. Sallie Mae, the largest lender under the FFEL program, is laying off 2,500 employees this year, a reduction of 30 percent of its work force.
Joe DePaulo, the company’s executive vice president, says Sallie Mae is still heavily involved in servicing loans and is looking to buy loan portfolios from lenders that were crippled by the credit crisis and the new law’s changes. According to its annual report to the Securities and Exchange Commission, Sallie Mae has four years left on a contract with the Education Department to service millions of federal loans and faces “very little competition” in that portion of the industry.
At least two major national banks, Key Bank and Citibank, have stopped lending money for education altogether, with Key Bank’s education division remaining in place only to service existing loans. Citibank sold its portfolio to Discover Bank last year.
Mark Kantrowitz, a student-aid expert and publisher of Finaid.org, says some lenders have come to him in the past year asking for his input on proposals to create new credit products for students. He declined to name the lenders, saying they had not decided whether to go through with the proposals.
Most of the proposals, he said, have characteristics of both student loans and tuition-repayment programs. Under one proposal, lenders would work with colleges to allow students to hold off on paying tuition until after college, when they would pay it back in installments over four to five years. The programs would have low interest, which wouldn’t begin accruing until after graduation, and an annual fee.
Lenders are also considering a repayment plan that would take a percentage of a student’s income rather than a fixed monthly payment, similar to the income-based repayment program put into effect by the Education Department last year.
That could lead to a variety of new options for students and families, Mr. Kantrowitz says, but whether those options would be good for students remains to be seen.
Hardest Hit
The government’s changes hit guarantors especially hard. Many are laying off workers, cutting programs, and transforming their business models.
Under the old bank-based loan program, about 34 organizations acted as guarantors, providing the first line of insurance against defaults and administering the loans at the local level. Many of them were state-based nonprofit organizations that performed a variety of functions, including servicing loans, administering state scholarship programs, and offering loan counseling. Some also offered loans to students.
Last year’s changes have all but eliminated the need for guarantors, although the Education Department will allow some of the state-based nonprofits to service a portion of its direct-loan portfolio and continue some administrative services locally.
Those organizations, like Vermont Student Assistance Corporation, face the prospect of layoffs and major cuts in their counseling and financial-literacy programs.
Scott Giles, the nonprofit corporation’s vice president for policy, research, and planning, says outreach programs for first-generation college students will serve about 250 fewer students this year. Over the next two years, he estimated that the organization will have to cut its budget by 18 percent. This week 58 members of its 300-plus-member staff took early-separation packages.
The cuts mean that counselors who help students fill out their federal student-loan applications and provide information on financial-aid options will be able to help fewer students.
Those services aren’t offered anywhere else in Vermont, Mr. Giles says. “That’s the part that’s really heartbreaking for us. If we don’t do the work, nobody will.”
The Vermont nonprofit is hoping to secure a contract with the Education Department to help service federal loans, but Mr. Giles isn’t sure the department will offer enough money to cover administrative costs. It received some state funds last year, for the first time since 1997, and is looking for philanthropic support.
Mr. Giles says the organization is now focusing mainly on administering the state’s higher-education grant program, just one of the many services it offered before.
Administrators of similar nonprofits in South Carolina, Louisiana, and New Mexico reported cuts in their outreach programs. South Carolina Student Loan, for example, will cut in half the number of presentations to schools, churches, and community groups it makes this year. Presentations will be made only at locations within an hour of the organization’s offices, in Columbia.
The Education Department is giving out about $19-million in grants to the lending industry this year toward retraining its workers, including many employees in local guarantor agencies.
The department also plans to release pricing information on loan-servicing contracts with nonprofit lenders and to solicit applications within the next two weeks from guarantors that want funds to help develop default-prevention programs, officials say.
American Student Assistance, which guaranteed loans in Massachusetts and the District of Columbia, has laid off about 75 staff members as a result of the changes, says its chief operating officer, Michael Finn. But despite the reduction in funds, he says the company will shift its focus toward loan counseling.
“There’s clearly a need out there for student-loan borrowers to get counseling and advice on how best to manage their student-loan debt,” Mr. Finn says. “And this frees us to go out and make a business of it.”
But Mr. Kantrowitz says there isn’t enough of a market for loan counseling and debt-management services to sustain the number of firms providing them. In the next few years, he predicts, many of those groups will fail.
“We have ... at least 50 entities trying to do something like that,” he says. “We don’t need that many.”
Kelly Field contributed to this article.
