Lenders Win Temporary Victory in Federal Student Loan Dispute

The massive highway bill passed by Congress last month contained more than funding allocations for various states and their roadways.

It also contained a provision designed to save the student lending program, as we know it, for another 90 days. Beyond that Sept. 30 deadline, however, it’s uncertain what will happen, although many people involved with the program are already predicting that smaller lenders will find more profitable ways to invest their money or restrict their lending to graduate students.

The problem stems from the formula, set by Congress, that dictates how much interest lenders can charge for student loans. Lenders contend the formula that was to have become effective July 1 sets the rates too low. Instead of being tied to short-term U.S. Treasury securities plus a 3.1-percentage-point margin, as the law allowed previously, the new formula based student loan rates on 10-year Treasury securities plus a 1-percentage-point margin – about 1.1 percent less than the old formula.

Under the temporary relief measure, lenders get a 30-basis-point reduction, but Congress must come up with savings to cover another 50 basis points, an amount estimated at $1.2 billion over a five-year period, according to the Education Finance Council, a national trade group based in Washington, D.C.

Lenders should have seen it coming. But, five years ago when the student lending program was up for reauthorization, lenders were more concerned about preserving the program itself than they were about an interest-rate formula that wouldn’t become effective for several years. At that time, in 1993, the Clinton administration was advocating a program in which the government itself would get into the loan business. Private lenders were determined to retain a share of the $30 billion loan market, and that’s where their lobbying efforts were focused, not on the new interest-rate formula.

As the July 1 date approached, however, bankers took a closer look at what the new formula would mean. Their conclusion was the new formula just wasn’t profitable enough for most private lenders to continue in the program, and they threatened to leave in droves as of July 1, a move that could have left 5 million students without loans for the fall.

This set off what the Washington Post referred to as a “game of chicken” involving the administration, lawmakers and banks. Lawmakers blinked first, coming up with the compromise that the President agreed to sign.

In Arkansas, one of the leading lenders to students is Simmons First National Bank, headquartered in Pine Bluff. David Bush, vice president of student lending, says the bank makes about $26 million in student loans annually. It is, he says, a “great program,” enabling virtually anyone who wants to attend school to do so. Parent loans are available even if the borrower has no collateral, and an individual can borrow up to $18,500 annually to attend graduate school, he says.

Also, a new law makes interest on student loans tax deductible.

It’s a good program from the bank’s perspective because there’s so little risk. Government guarantees ensure the lender will get back 98 percent of the loan, even if the borrower defaults. And, although student loans may not be the most profitable transactions for banks, many lenders see it as a way to begin building customer loyalty.

Barbara Chiapella, federal legislative representative for the American Bankers’ Association in Washington, D.C., predicts that most lenders will leave the program, as they have been for the past half-dozen years.

“As rates continue to get cut, more and more banks will get out,” Chiapella says. “Banks ought to be able to compete but, with the federal government on the other side subsidizing low-student [interest] rates, that makes it difficult.”