Student-Loan Firms Leave the Program

Several student-loan lenders are backing out of the federal program, the result of the credit crunch and government subsidy cuts that have made the business of lending to students increasingly unprofitable.

Big banks, such as Wells Fargo & Co., might be reluctant to pick up the slack as other lenders exit, because they are already stretched by the credit crisis. The government, already a big student lender, could step in to shore up the system, although that would be complicated.

Monday, Brazos Higher Education Service Corp. became the latest lender to suspend new loans to students through the Federal Family Education Loans program, or FFEL, for the 2008-2009 academic year. Brazos, a 33-year-old company based in Waco, Texas, is one of the nation's largest student lenders, with a portfolio of $15 billion in education loans. It joins a list of at least 26 other lenders that have stopped providing such loans, according to FinAid.org, a student-financial-aid publication.

An estimated eight million students and parents will seek $109 billion through FFEL for the coming fiscal year, according to Education Department data. If lending continues to tighten, it could push up their costs.

"We've seen a dramatic reduction in borrowers' opportunities," says Deborah Fox, founder of Fox College Funding LLC, a San Diego company that advises families on paying for college.

The void that the lenders leave already accounts for almost 10% of the total estimated loans needed this year, according to one industry estimate.

"I think you will see a larger number of lenders exiting this market," said Sameer Gokhale, an analyst with Keefe, Bruyette & Woods. "They are not making money on these loans."

Samara Yudof, a spokeswoman for the Education Department, wrote in a release that U.S. officials "are concerned about the uncertainty in the current market and are weighing all options available" to ensure federal student aid continues to be available.

Department officials maintain that with nearly 2,000 lenders taking part in the FFEL program, others, particularly banks, will pick up the volume from institutions that stop lending. The vast majority of those lenders are relatively small players in the student-loan arena. The top 50 FFEL lenders account for more than 83% of all loans made under the program, according to FinAid.org. Three banks that rank in the top 50 exited FFEL last week.

SLM Corp., commonly known as Sallie Mae, is the biggest lender in the industry. Banks comprise more than 40% of student-loan originations.

Little Incentive for Lenders

For Wells Fargo, "student loans are not a profit-making business," said Michael DeVito, executive vice president of education financial services for Wells Fargo, which ranks fourth in annual origination. "We are here to meet the demand and the need of our customers," he added, but "in terms of trying to use this as an opportunity to take market share, that's not our strategy."

Citigroup, which is the nation's second-largest student lender, also has no plans to aggressively expand its current FFEL lending operations, said a person familiar with the situation, noting the weak securitization markets. Cleveland's KeyCorp, a top-50 lender, says it isn't looking to grow into "new places we've never been before," says Richard Vonk, president of Key Education Resources.

J.P. Morgan Chase & Co., the nation's seventh-largest originator of student loans, has said it plans to increase its share of the student-loan market, but spokesman Tom Kelly declined to specify if the expansion will concentrate on FFEL loans or the more-lucrative private variety.

Students in the 2006-2007 government fiscal year are estimated to have borrowed $114.8 billion through federal loan programs. That includes new loans and loans used to consolidate or refinance existing loans. Of the total, about 85% were FFEL loans, according to government data. The rest are direct government loans.

In addition, students borrowed an estimated $18.5 billion in private and state-sponsored loans. Private loans are not controlled by the government and often carry higher interest rates.

Three Strikes; They're Out

A storm has hit Brazos and its competitors in the past six months.

First, the auction-rate-securities market, an important source of financing for many lenders, collapsed. That doubled some lenders' costs overnight.

Meantime, the cost of borrowing in the longer-term asset-backed securitization market, where more than half of all loans were securitized, has risen. For instance, Citigroup's Student Lending Corp. securitized $1.9 billion in student loans at Libor plus 1.4%, compared with deals at Libor plus 0.10% last June.

The market turmoil combined toxically with last fall's College Cost Reduction Act, in which the government slashed lenders' subsidies by more than $20 billion, or roughly in half.

If private lenders don't fill a void that develops at FFEL, the government could be left to come up with another solution. The Education Department and industry participants are reviewing contingency plans for Lender of Last Resort, a program that is untested.

The government also has a direct-lending program, which could take up some of the FFEL market share. This would require schools to switch their systems and relationships quickly. Boston's Northeastern University and Pennsylvania State University have taken that step.

Write to Liz Rappaport at liz.rappaport@wsj.com and Robert Tomsho at rob.tomsho@wsj.com