The drop in yields on government bonds has galvanized the student loan industry to push for an interest rate formula pegged to the capital markets.

As the industry gathers this week at the Consumer Bankers Association's student lending conference, changing the interest rate structure-now tied to Treasury bills-is taking shape as the top legislative priority for the incoming Congress.

"That's the headline story for 1999," said Joe Belew, president of the Consumer Bankers Association. "I don't think there's anything of that magnitude on the horizon."

The industry has not yet determined whether such a change will cost taxpayers more money. But it claims that switching to a market-based rate would not affect the rates that students pay and would bolster the market by making selling the loans more lucrative.

Currently, banks that make student loans receive an interest rate that is calculated by adding 280 basis points to the 91-day Treasury. Most of that rate is charged to the students, and the rest-roughly 50 basis points- is covered by the government.

To fund those loans, and to raise money to buy them on the secondary market, financial institutions borrow money in the capital markets at the generally more expensive London interbank offered rate, or Libor.

When investors' so-called flight to quality began this fall, yields on Treasuries fell sharply, increasing the difference in rates between Libor and the 91-day Treasury, known as the TED Spread (Treasury to Eurodollar).

A large TED Spread, the industry maintains, wipes out the profits in making and buying student loans and threatens the entire private lending program.

"If financial market conditions stay where they are, it will be very difficult for lenders to continue to finance student loans over an extended period of time," said Mark J. Weadick, a director in the investment banking division of Salomon Smith Barney in New York.

That point was clear in SLM Holding Corp.'s third-quarter earnings report. SLM, better known as Sallie Mae, is the country's largest purchaser of student loans on the secondary market. But SLM securitized no loans during the third quarter "due to unsatisfactory market conditions," according to the company's earnings statement.

That was partly why SLM reported a 24% drop in earnings from the same quarter a year earlier. In the third quarter of 1997, SLM had raised $159 million securitizing student loans.

This is not the first time that banks have threatened an exodus from the program in order to wrest concessions from Congress.

This summer the industry hammered out a compromise with Congress and the White House, which wanted to cut the rates that banks could charge students by 80 basis points.

The industry effectively lobbied the government to absorb some of the cut, thereby reducing it to 30 basis points. That funding was included in the Education Act Amendments, which President Clinton signed in October.

But the act provided a window for future changes. It called for a study of the feasibility of using alternative financial instruments to determine lending yields. The report is due to be delivered to Congress in the spring.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.