CHICAGO - Changes in the federally guaranteed student loan program contained in President Bill Clinton's budget may spur secondary market loan agencies to issue more debt to purchase loan portfolios from lenders.
Laurie Quarales, deputy director of the National Council of Higher Education Loan Programs, which represents providers of financial aid for students, said there is "great expectation" of expanding the loan purchasing greope of the secondary market agencies, which buy student loan portfolios from banks through the issuance of tax-exempt and taxable debt.
"The general impression is there will be smaller lenders who will be more anxious to sell their loans," Quarales said. The feeling is the secondary market will see an increase in volume."
The expected sell-off of loans by banks is grounded in the Clinton budget, which contains disincentives for banks to make student loans.
Robert Holloman, managing director of the structured finance group at Smith Barney, Harris Upham & Co., said that provisions in Clinton's budget call for decreasing banks' share of the guaranteed student loan market to 60% of the total loan volume in five years. The decrease would then make way for the federal government to issue loans directly to students.
In addition, banks will be charged a 50 basis point origination fee payable to the U.S. Department of Education starting in October and will only receive a federal guarantee on 98% of a loan instead of the current 100%. For student loans made after July 1, 1995, interest rates charged by banks can only be 2.5% more than the Treasury bill rate, compared to the current 3.1 % spread over Treasuries.
"Banks will be looking to downsize lending or get out of the [student loan] business entirely," Holloman said.
With that in mind, an Ohio-based nonprofit secondary market for federally guaranteed student loans recently sold $1 00 million of tax-exempt bonds to lay the groundwork to purchase more student loan portfolios in the future.
"We anticipate significant demand for our services as a result of the legislative reforms that put the current public-private partnership in competition with the federal government to provide student loan capital and quality student borrower services," said Thomas L. Conlan Jr., president and chief executive officer of Student Loan Funding Corp. in Cincinnati, in a press release.
The company sold $90 million of student loan senior subordinated revenue bonds and $10 million of junior subordinated revenue bonds in July and closed on the deal, headed by Smith Barney, last month. The bond proceeds will be used to purchase student loan portfolios from banks that meet federal tax-exempt requirements.
The deal essentially installs an underlying structure for the future issuance of up to $900 million of taxable floating-rate senior lien notes that the Cincinnati corporation will use to purchase more student loan portfolios. according to Holloman, the senior underwriter on the deal.
Holloman said the corporation would have to issue taxable securities because, under federal law, the corporation can only tax-exempt bonds only if it has allocation under Ohio's volume cap and if the bond proceeds are used to buy student loans made to Ohio residents or out-of-state residents attending Ohio schools.
He said the corporation "is fairly comfortable" that there are enough Ohio-related student loans available for purchase with the $100 million of tax-exempt bond proceeds from the recent deal.
The $90 million of senior subordinated bond were rated A1 by Moody's Investors Service and A-plus by Fitch Investors Service. The $10 million of junior subordinated bonds were rated A by both agencies.
Holloman said the taxable senior lien notes are expected to earn a triple-A rating from Moody's and Fitch because the bondholders will have a first call on the corporation's assets before the recently issued senior and junior subordinated debt. However, before any senior lien debt can be issued, the rating agencies must affirm the rating on the subordinated debt, according to officials at Fitch and Moody's.
Review Senior Lien Debt
The officials said they would review any senior lien debt the corporation issued to see if the debt meets the triple-a test and does not impair the rating on the subordinated debt.
David Howard. a senior analyst at Fitch, said the subordinated debt will act as a credit enhancement for the senior lien debt because senior debt would be able to tap, if needed, the cash flows used to support the subordinated debt.
By having the debt issuance structure already in place from the recent $100 million bond issue, the corporation can move quickly to bid on bank loan portfolios, Holloman said.
He estimated that the time frame for making the bid, taking the deal to the rating agencies, and issuing the securities will be compressed to 30 days from 90 days.
"I think this is a fairly innovative transaction, and management is trying to position itself for what's happening in that industry," Holloman said.
Howard agreed that the corporation would be able to move more quickly in acquiring a rating for senior lien debt because of the rating agency"s familiarity with the subordinated debt. While Standard & Poor's Corp. was not asked to rate the issue, Ellen Welsher, an associate director at the agency, said the agency does rate similar deals.
Paul Wozniak, a first vice president in the municipal securities group at PaineWebber Inc., said that in the near term, the Clinton budget and low interest rates have created "a fair amount of issuance" by secondary market agencies.
"They've done a lot of refinancing and new money in the near term and have adequate capital to meet their needs." he said.
For example, the Nebraska Higher Education Loan Program Inc. has sold two deals of new money and refinanced senior notes and subordinated bonds. Don Bouc, the program's president, said the deals also put into place a structure to allow the company to issue up to $1 billion of taxable senior notes in the future to buy student loan portfolios.
"If banks do want to get out of the [student loan] program, we have the capacity to issue senior notes on a quick basis," said Kurt Bollish, the program's vice president of finance.
Bill Hansen, executive director of the Education Finance Council, which represents secondary market agencies, said many of the 43 agencies may wait until the 1995. academic year to sort through the student loan changes and their possible impact.
Over the long-term, however, Wozniak projected that those changes will lead to additional debt issuance by the agencies.