By Peter Wood
A few weeks ago, I alerted readers to the threat of a tightening of the student loan market . Banks have been bundling student loans, like home mortgages, and selling them as securities. First Marblehead Corporation in Boston has been the nation's biggest player in "securitizing" student loans, and just like home mortgage-backed securities, the student loan-backed bonds issued by First Marblehead contain a lot of loans of doubtful value.
These aren't the loans that are guaranteed by the Federal government's Title IV Student Loan program. When students have borrowed all they can in Title IV loans, they frequently need to borrow still more to meet the extravagant costs of college. They often borrow at relatively high interest rates from banks and other private lenders. These banks and lenders, in turn, act just like the sub-prime mortgage lenders did: they sell the risk to someone else. First Marblehead takes loans from many banks and bundle them together to create its bond issues.
As I reported, First Marblehead appears to have hit a major snag in October, when investors declined to buy the company's new $1 billion student loan-backed bond offering. First Marblehead's stock plummeted and a chill went through the whole student loan industry.
News on two fronts
First, First Marblehead's stock surged on December 21 on news that Goldman Sachs Group Inc. had invested $260.5 million in the company. This gives Goldman Sachs a 20 percent interest in First Marblehead. Moreover, Goldman Sachs agreed to lend First Marblehead up to $1 billion, presumably covering the failed bond issue.
In layman's terms, First Marblehead just got bailed out. The financial experts, however, are more cautious. The Associated Press quotes Mark Spoule, an analyst with Thomas Weisel Partners, saying the Goldman Sachs' investment "stabilizes but does not alleviate" concerns about whether First Marblehead will be able to continue to securitize student debt.
That depends on the willingness of investors to buy up loans from students who, as a whole, are not very attractive credit risks. In many cases, the students have no collateral, are carrying other heavy debt burdens, and are pursuing degree programs that don't prepare them very well with marketable skills or well-paying specializations. With the sub-prime mortgage mess continuing to reverberate, investors are chary of taking on other mystery-meat securities.
The other news is that an even bigger player in the student loan industry, Sallie Mae, is making strange noises. Last April, Sallie Mae began seeking approval to sell itself to a group of investors led by J.C. Flowers & Company for $25 billion. The deal foundered on political reactions to the student loan scandal, with Senator Kennedy and Congressman George Miller (D-Calif.) citing the proposed buy-out as evidence of how the financial loan industry was making excessive profits. That impression wasn't dented by the $25 million farewell package that Sallie Mae's then chief executive Thomas Fitzpatrick received when he stepped down. Then in September, Congress reformed the federally-guaranteed student loan program ("the College Cost Reduction and Access Act") in a manner that narrowed lenders' profit opportunities. In early October, J.C. Flowers & Company and other would-be investors decided that their $25 billion offer was no longer on the table. They reduced it by 20 percent. Sallie Mae continued to negotiate but the whole thing collapsed last week, which prompted a conference call on December 19 by Alfred L. Lord, Sallie Mae's new chief executive, to investors and analysts to tell them not to worry; Sallie, the old gal, is OK. Then he used an expletive that rhymes with duck. [See transcript here.]
Investors replied by vociferously quacking, "sell, sell, sell," and, as the New York Times put it, "sent Sallie Mae stock into a tailspin." The stock splashed down at $22.89, a 20.7 percent dive, "the worst one-day drop in the company's history." It was the investors way of paraphrasing Mr. Lord. "Let's get the duck out of here." In the days that followed it sunk even further.
Sallie Mae responded to its share of the bad news with some announcements. First, it intends to shift a greater portion of its business out of government-backed loans into the higher-interest-bearing private loans. At the moment only 17 percent of Sallie Mae's outstanding loans are private. (Yes, it is increasing its stake in the same business that has lately confounded First Marblehead.) Second, faced with the failure of its Flowers buy-out, Sallie Mae issued new stock. It says it sold $3 billion of common and convertible preferred shares, which The Wall Street Journal reported as "$500 million more than it initially expected." The stock price as of January 1 was $20.14. The new capital apparently hasn't been enough to improve the company's stock price or its credit rating, which is just above junk-bond status.
There are not enough dots yet to draw a picture of a credit squeeze in the U.S. for student loans, but it might be a good time to start watching for more dots.
Peter Wood Is Executive Director of the National Association Of Scholars