24 Hours Later...10 Questions About Obama's Direct Lending Plan

Well, now that the shock has worn off somewhat, I thought it would be interesting to think about the major questions raised by President Obama's budget blueprint which details a shift to direct lending by the 2010-11 academic year.  Remember that this blueprint needs to work its way through Congress, and as such, is subject to change.  Since few details are available at this time, I thought it would be more useful to think about questions raised by this announcement. 

10.  Why were all shocked by this announcement? 

• Candidate Obama was unambiguous on the campaign trail about wanting to move the federal loan program entirely over to Direct Lending.  Was it the surprise that a politician would actually keep his campaign promises or the success of the government interventions to prop up FFELP that led folks to assume that the status quo would continue?

9.  Will this announcement accelerate schools moving to Direct Lending?

• An SLA flash survey of financial aid administrators this fall indicated that over 1/3 of current FFELP participants were considering or had committed to moving to Direct Lending for 2009-10.  The timing of this announcement is critical since many schools considering such a switch would be finalizing their decisions now (for schools that have recently made the decision see here and here and here and here).  Given that there will be lingering doubt about the status of FFEL for several months, might this be the nudge that pushes more people over to direct lending?

8.  Will we now get legislative action that postpones the Parent PLUS auction? 

• It all seems to make more sense now.  Why would the Department of Education have wanted to move the auction process forward if their intent was to eliminate FFEL in 2010-11?  I think it is safe to assume that the auction will not be going forward.

7.  What incentives will lenders have to continue to participate in FFEL for 2009-10 if they know the Administration is planning to eliminate the FFEL program a year later?

• This is a very real concern to financial aid administrators who are currently developing their lender lists for 2009-10.  Given the marginal profitability (as reported by the lending community) of the current loan purchase and participation program, what incentive will the FFEL community have to continue their participation in the program.  One wonders whether there could be another exodus of lenders from the marketplace should the Administration move forward with their DL plans given the bleak long term prospects for FFEL lenders.  Will the Department improve the terms of the loan purchase and participation program to ensure participation?  

6.  How will the Department of Education ensure a smooth transition over to Direct Lending within the next 18 months?

•  While planning can begin now, this proposal to move 100% to DL must first make its way through the budget process before implementation can officially begin.  Current estimates are the Direct Lending manages about 1/3 of the federal loan volume with FFEL the other 2/3.  I estimate that this ratio could get to 50/50 for 2009-10, so DL would have to double its capacity to manage in 2010-11. 

5.  What leverage do FFEL lenders have to exert against this proposal?

• They still managed almost 2/3 of the federal loan volume in 2008-09 and are likely to have at least half of the volume for 2009-10.  In turn, the Department of Education has some leverage to keep lenders in line, as they will be using "competitive, private providers to service loans."  This means that FFELP lenders with efficient servicing capabilities will have opportunities to garner some of the DL volume, presumably through a competitive RFP process.

4.  (I may be thinking too far down the road here) How many servicers will the Department be choosing to manage the program?

• The "experience curve" was a concept I was introduced to early in my consulting career. At its core, this concept predicts that the company with the most accumulated experience in an activity will enjoy a cost advantage over its peers.  This matters in activities such as loan servicing where Sallie Mae's market share advantage should translate into their ability to service loans at a significantly lower cost than its peers.  They, with the current DL servicer, ACS, would seem to have a distinct advantage over their peers when it comes to a low-cost bidding process.  This may also explain Sallie Mae's conciliatory response to yesterday's announcement: 

"We are proud that in this economic crisis, we provided more loans to more students than ever before, and we did it using lower-cost federal funding similar to what is being proposed today," said Al Lord, Vice Chairman and Chief Executive Officer. "We look forward to bringing these same resources to the table to help the Administration and Congress achieve their objectives."

A key challenge for the Department will be to structure the contracts to ensure competitiveness  given that there will only likely be a small number of players (e.g. Sallie Mae and ACS) that will   have the economies of scale to compete. They may, in the short-term, need to support other less efficient servicers to ensure competition in the servicing arena. 

3.  What are the details behind the $4 billion cost savings estimate in the budget? 

2.  Will existing FFELP loans continued to be serviced by FFELP lenders or by Direct Lending?

• If so, I suspect we will see a consolidation of servicers as sub-scale players sell their portfolios and exit their markets. 
  

1.  What impact would a shift to Direct Lending have on the private loan market? 

• While the private loan market has been the profit engine lately on the student lending P&L, will this equation change without FFELP loan volume to absorb some of the sales, marketing and administrative overhead costs?  

Bonus question:

• What impact will the announcement have on the various federal programs about to be implemented including the conduit and TALF?  Will investor interest wane in light of uncertainty surrounding the FFELP program?   

Please post any additional questions you might have below in the Comments. 

Comments

[Lloyd Leanse]

Regarding #10 - I thought the best arguments for retaining and actually improving the "bank" based program were 1) even the US government can only borrow so much money and this forces it to borrow tens of billions more than it needed to in the good old robust FFEL days and 2) the guarantors really do provide a lot of hands on default prevention and face-to-face time with high school counselors and college financial aid teams.

Regarding #3 - I would like to see this analysis, too.

In general, I am surprised to not see any response from NCHELP (at least looking on its website as recently as yesterday.)

[Alex Hamilton]

Tim, what's your take?

Will your clients that are FFELP schools be better off moving to the Direct Loan school? Will they be better off having absolutely no choice in the matter?

Will your clients that are in the Direct Loan program be better off if the department no longer has any competition from FFELP? Over the long term do government bureaucracies do a better job than the private sector? Do government bureacracies do a better job when there is a private sector alternative?

Is the nation better off that FedEx, UPS, DHL, etc. exist and compete with the Post Service?