Lenders need new financing

Student-loan providers scramble as key credit market fails

An important credit market for student loan lenders dried up this week, sending the North Carolina agency that administers $3.3 billion in student loans scrambling for new financing.

The need to refinance debt is another unexpected consequence of the credit crunch in a market that most investors never knew existed.

If the refinancing goes smoothly, students and families might never know there was a problem, said Steve Brooks, director of N.C. State Education Assistance Authority.

But if other credit markets seize up as quickly as the one that failed this week, Brooks said student loan lenders would face a crisis.

"I don't think that is going to happen, but it would be a worldwide crisis if other markets seized up that fast," Brooks said. "Our problems would pale."

The market that failed this week involves an investment known as auction-rate securities. Though virtually unknown to individual investors, it is important to thousands of North Carolina families and students. That's because more than two-thirds of the state's $3.3 billion in student loans were financed using the auctions.

But the auction relies on the willingness of banks to buy the securities if no one else places a bid.

This past week, banks were unwilling to take that step, because they weren't sure they could turn around and sell the securities to someone else, if needed.

At that point, the auctions failed.

Under the terms of the securities, that meant the issuers had to pay the security holders a higher interest rate. It also meant that avenue for raising money had just dried up.

"The whole notion of a failed auction when I started 10 or 11 years ago was unthinkable," Brooks said. "The same could be said three weeks ago. I'm not sure when -- or if -- they are coming back."

The failure has nothing to do with the authority's credit rating or the value of its assets. Both are strong.

"But it speaks directly to people's confidence and trust in the credit markets," said UNC-Charlotte finance professor Tony Plath.

The failed auction stung some agencies harder than others.

The Michigan Higher Education Student Loan Authority announced Tuesday that it would suspend one of its lending programs after the auctions failed.

N.C. in better shape

N.C. State Education Assistance Authority, which handles 60 percent of the student loans in the state, isn't worried about having to take such action.

Current loans agreements are not affected, and the authority has started working on raising money for next year, Brooks said. The agency needs about $600 million to cover student loans for the 2008-09 school year. That money will come from the sale of a different type of security.

After that, the authority would need to refinance the remaining debt, initially issued through auction-rate securities.

But barring a turnaround in the markets, tighter credit could eventually increase the cost of student loans.

Some changes have already happened with private lenders, such as Sallie Mae tightening credit requirements.

Others lenders have considered reducing discounts previously built into the loans.

"I am watching it all at arm's length," said Julie Rice Mallette, director of the office of scholarships and financial aid at N.C. State University. "The economy as a whole is a concern to me. When there is trouble in the banking industry, it is going to have an impact on everyone."

Most students cover the cost of college with a mix of family money, scholarships, grants and government loans.

If that combination isn't enough to cover the bill, student loans are also available from private lenders.

Private lenders make up a small portion of the student loans at most public universities, but at some smaller private and trade schools, they are a more important part of the aid package.

Brooks said he isn't opposed to tightening requirements if it keeps students and families from taking on debt they can't handle.

"But none of this works without credit and liquidity in the markets," he said. "Without that, you don't have anything to work with."