Washington Starts to Move on Lenders' Student Loan Problems

Defaults are the leading problem in education lending today. Virtually every requirement the Department of Education imposes on lenders in the Guaranteed Student Loan Program aims to address this problem.

Are lenders to blame? Increasingly, the answer is no.

Public and private sector experts now attribute burgeoning default rates more to shoddyand fraudulent schools, particularly trade and technical schools. Defaults are also attributed to poor federal program administration and, most important, to a dramatic 1980s shift away from federal grants to needy and deserving students.

Defaults More than Triple

The 83% increase in student loan volume from 1983 to 1989 is overshadowed by the concurrent 350% increase in gross defaults. Student loan defaults now total over $2 billion and are expected to peak at close to $3 billion in 1992.

What has Washington really hopping is the Guaranteed Student Loan Program's bottom line. As a percentage of total program costs, default costs rose from about 10% in 1980 to 36% in 1989.

The problem of soaring defaults was made painfully clear when the largest agency guaranteeing student loan portfolios went into default last year.

Guarantee agencies insure and monitor student loan lenders and, in turn, are reinsured by the federal government.

The Higher Education Assistance Foundation guaranteed about $2 billion in student loans at the time of its demise, or about 14% of total student loans outstanding. The Student Loan Marketing Association, also known as Sallie Mae, is now overseeing a three-year workout of Higher Education Assistance Foundation's commitments.

Small Profits, Big Problems

The declining profitability of guaranteed student loan portfolios has long troubled consumer lenders.

Under current regulations, servicing these student loans is particularly cumbersome and costly. In September 1988 about 11,000 lenders were active originators of guaranteed student loans, but their ranks had declined to 9,000 just one year later.

Even this level of participation is deceiving. The top 25 lenders account for almost 37% of today's total student loan origination volume; the top 100, 64%.

Moreover, guaranteed student loans are routinely sold before entering repayment. Sallie Mae alone holds about one in four of these loans.

Viewed historically, this concentration represents a continuing trend: More lenders, especially smaller institutions lacking the economies of scale in servicing, are ceding market share to larger or more focused institutions.

Is there a bright side to this rather bleak picture? Fortunately, the answer is yes. Education lending still represents a business opportunity to lenders with suitable volume and the focused servicing and collection systems that can eke out a sufficient portfolio return.

By responding to community demand, most active program lenders, large and small, are also creating future cross-selling opportunities, since today's students are tomorrow's earners, consumers, and homeowners.

To Washington's credit, congress and regulatory agencies are showing awareness of the problems lenders face.

Congress is preparing to reauthorize the student loan program's governing legislation -- the Higher Education Act -- and is listening to lenders' concerns about onerous regulations, default rates, and the financial stability of guarantee agencies.

On the regulatory side, the Department of Education has already implemented numerous default-reduction reforms, which are just beginning to take effect and are directed at student borrowers and schools more than lenders.

The new education secretary, Lamar Alexander, clearly does not believe that time heals all wounds. Within a month of taking office, and in full recognition of the problems besetting federal management of the loan programs, Mr. Alexander had already initiated a major departmental restructuring.

All the various student financial assistance offices are being combined, and an outsider with management experience in the public and private sectors has been tapped to run this new office.

The secretary has also just presented the administration's own preliminary legislative package for the reauthorization of the Higher Education Act.

Changes to the student loan programs would include an increase in loan limits to offset five years of inflation and an authorization for guarantee agencies to garnish defaulted borrowers' wages.

To Head Off Defaults

In a continuing attack on defaults, lenders would be required to:

* Perform credit checks on student borrowers 21 or older.

* Delay the disbursement of loans 60 days to first-year borrowers at schools with defaults exceeding 30%.

* Provide for graduated repayment options.

Finally, the administration's legislative proposals for reauthorization will also include provisions from its 1992 budget package.

Among these proposals are a 25-basis-point cut in the government rate paid on guaranteed student loans for those lenders experiencing portfolio default rates greater than 20%.

Another provision is a requirement for the states to back guarantee agencies with their full faith and credit. In this way the states would share with the federal government some of the costs of meeting lender default claims in the event of an agency's insolvency.

These proposals do not address all concerns, but they are nonetheless very promising and indicate an awareness on the part of the Department of Education that lenders are not a primary cause of the default problem. Perhaps the time is at hand for real regulatory relief.

Mr. Ian W. Macoy is the federal representative for the American Bankers Association, Washington.

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