Looking at lending: want to make money and serve your students better? Some colleges are doing this by underwriting loans to graduate students

Matrix: The Magazine for Leaders in Education, Oct, 2001 by Judith Harkham Semas

Saint Mary's University-Texas had a problem. Graduate students complained that, instead of the single loan payments they expected when they first sought financial aid, they were getting bills from a number of lenders.

"We were frustrated because financial industry consolidation and lenders selling their loans to varying secondary markets often saddled our students with multiple repayments to multiple lenders after they left school," says Dave Krause, St. Mary's director of financial assistance. "Students would borrow money from Bank X, which would be merged, or would sell its loans to Sallie Mae one year and to another secondary source the next--without serializing the loans to assure a single lender for our students to repay."

That was in 1992, the year St. Mary's began looking for an alternative. What they found is fast becoming a popular way for higher education institutions to generate substantial new income and benefit students simultaneously.

They became lenders.

The vehicle for this up-and-coming initiative is a provision of the Federal Family Education Loan Program that allows schools to assume the part of the student lending role traditionally held by banks.

University financial directors experienced with this program say that if you plan well and work with Knowledgeable professionals, everybody wins.

St. Mary's now makes $9 million to $10 million a year in direct family education loans to its graduate students. As the school knew, secondary markets pay premiums for the loans they buy. Premium rates are negotiated based on average loan amount, dollar volume generated, loan default rate and market competition.

Secondary markets consider federal graduate student loans good investments because the borrowers are expected to enter high income-generating fields, and because the loan amounts are higher, on average, than for undergraduates.

Undergraduate loans are less appealing for direct school lenders because of the federal loan program's restrictions. "The school can act as lender as long as it doesn't lend to more than 50 percent of its undergrads, and a commercial lender has turned the student down," Krause says. "But these days everyone is making loans. The Federal Family Education Loan Program includes government guarantees, so there are no turndowns." With the graduate student population, such restrictions do not apply.

The University of Oklahoma began making direct loans to its graduate students in 1996. Since OU is a public institution, a line of credit wasn't an option, so the school turned to the Lew Wentz Foundation, a $14 million private group that exists to make loans to students, so the federal direct school lending program fit perfectly.

Matt Hamilton, OU's associate vice president for admissions, records and financial aid, sought proposals to outsource the loan servicing involved: origination, funding, service and sales agreement. "I was looking to accept one proposal," he says, "but it could involve several entities."

OU accepted the proposal from Boatman's Bank (now merged into Bank of America) as the funder with Sallie Mae as the originator, servicer and secondary market buyer. Under the agreement, Bank of America and Oklahoma Student Loan Authority now provide the funding/service/secondary market package. "It was a good deal for the students, and earned a better premium for us," Hamilton says.

Western University of Health Sciences is in its second year of the program. "We've gained much by becoming a lender," says Otto Reyer, director of financial aid. "We eliminated the origination fee for our graduate students. Normally, they'd pay 3 percent of the loan value. Now when our students borrow $1,000, they get $1,000, not $970."

WUHS went with Student Loan Funding, based in Cincinnati (later bought by Sallie Mae), USA Group as servicer and Firstar Bank of Cincinnati for interim financing.

St. Mary's borrows the money it lends under a specially negotiated line of credit with Bank of America. The credit line borrowings are paid off when the loans are sold to the secondary market source (currently Sallie Mae), which pays a premium for the assets.

Typically loans are made in two disbursements that pay for fall and spring tuition, and St. Mary's sells its loans each spring after the second disbursement. Selling to the secondary market on an annual basis is typical at most schools that are Federal Family Education Loan Program lenders.

"With a graduate student loan volume of, say, $10 million, most schools could be making 3 percent to 4 percent, and generating upwards of $300,000 to $400,000 in annual revenue," says Krause.

The government also pays schools a special allowance while they're holding these loans, but the line of credit is an offsetting cost. "There's a slight variance between the two figures from year to year," he says, "but over time we've found that they tend to cancel each other out."

David Gruen, University of Denver director of student financial services, says he has seen premiums as high as 7 percent from secondary markets. The school's program encompasses direct loans from the school, both under and outside the federal loan program. "In our first year in the program, we did about $11 million out of a potential of $40 million," Gruen says. "This year we're on target for $20 to $25 million. As we approach $35 million we'll have to decide whether to continue both approaches or just use the federal program."