Loan companies forced to freeze funds, downsize
Due to recent economic collapse, lenders cut back to stay afloat
According to American Student Assistance (ASA), a non-profit student loan guarantor, the federal lending program is currently stable.
The crisis in the student lending market originated from the collapse of the sub-prime mortgage industry in early 2007.
"It is vital to understand that these lenders are not banks; they need to get their money from somewhere," Kantrowitz said.
Educational lenders use a credit warehouse facility - a short-term loan from a large international bank - to fund student loans. However, these large, short-term loans tend to be expensive.
In order to obtain a cheaper source of capital, lenders securitize their loans, transfer them to a trust and sell shares to investors.
The process provides lenders with the original balance of funds plus a premium, which lenders use to fund student loans and pay for operational expenses. In return, investors are guaranteed some income from the loans.
This system requires a large initial investment by the lender (at least $100 million), favoring larger firms in the process. In order to increase profit, lenders focus on increasing the number of loans.
Educational lenders generated massive profits under this system. In 2006, Sallie Mae, the largest student-lender in the country, originated $16 billion in government-guaranteed loans and an additional $7.4 billion in private loans. The company's return on equity was over 30 percent, one of the highest among American companies.
The success, however, was short-lived. In 2007, Congress passed the College Cost Reduction and Access Act, which reduced the number of subsidies that went to private lenders and re-invested the money in Pell Grants and Stafford Loans.
While a major gain for college students, the Act reduced profit margins for student lenders and forced many corporations to cut back on lending.
The situation was exacerbated in August 2007 when problems in the sub-prime lending market began to spread to the securities market. Investors, weary of the housing market collapse, lost interest in the educational securities market, resulting in decreased liquidity (usable money) in the lending market.
The crisis in the student lending market originated from the collapse of the sub-prime mortgage industry in early 2007.
"It is vital to understand that these lenders are not banks; they need to get their money from somewhere," Kantrowitz said.
Educational lenders use a credit warehouse facility - a short-term loan from a large international bank - to fund student loans. However, these large, short-term loans tend to be expensive.
In order to obtain a cheaper source of capital, lenders securitize their loans, transfer them to a trust and sell shares to investors.
The process provides lenders with the original balance of funds plus a premium, which lenders use to fund student loans and pay for operational expenses. In return, investors are guaranteed some income from the loans.
This system requires a large initial investment by the lender (at least $100 million), favoring larger firms in the process. In order to increase profit, lenders focus on increasing the number of loans.
Educational lenders generated massive profits under this system. In 2006, Sallie Mae, the largest student-lender in the country, originated $16 billion in government-guaranteed loans and an additional $7.4 billion in private loans. The company's return on equity was over 30 percent, one of the highest among American companies.
The success, however, was short-lived. In 2007, Congress passed the College Cost Reduction and Access Act, which reduced the number of subsidies that went to private lenders and re-invested the money in Pell Grants and Stafford Loans.
While a major gain for college students, the Act reduced profit margins for student lenders and forced many corporations to cut back on lending.
The situation was exacerbated in August 2007 when problems in the sub-prime lending market began to spread to the securities market. Investors, weary of the housing market collapse, lost interest in the educational securities market, resulting in decreased liquidity (usable money) in the lending market.
Viewing Comments 1 - 2 of 2
collegeloanconsultant
posted 2/13/09 @ 8:29 AM EST
While traditional lending institutions are not participating in private loans, there are a number of alternative lending models that have begun to take hold, filling the void. (Continued…)
Payday Loans Freeze
posted 2/13/10 @ 6:01 AM EST
Lending companies have always found ways to adapt but this has certainly effected many different areas in the banking and lending industry.
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