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SAFRA One Year Later

It's been a year since the Student Aid and Fiscal Responsibility Act took effect. How is it working and what is to come?
University Business, June 2011

The Student Aid and Fiscal Responsibility Act (SAFRA), passed in May 2010 as part of the Healthcare Reform Act, was an attempt to rein in the student loan industry and save money by taking private lenders out of the equation. But a year later, educators, parents, and legislators are asking, is the program delivering on its goals?

SAFRA was the result of a contentious decades-long battle to end private loans and dismantle the Federal Family Education Loan (FFEL) program in favor of the Direct Lending (DL) program managed by the Federal Student Aid (FSA) office of the U.S. Department of Education. Proponents of Direct Lending--perennial advocate Bob Shireman, a former Department deputy, for one--have been pushing the concept for decades. The tipping point that brought that to fruition actually came two years earlier.

Anticipating the FFEL-to-DL program and wary of the worsening credit crunch, Congress passed the Ensuring Continued Access to Student Loans Act (ECASLA) in October 2008. It authorized Arne Duncan, the U.S. Secretary of Education, temporary authority for the Education Department to purchase FFEL loans--effectively providing a secondary market for these loans. The FFEL program constituted 78 percent of the total dollar amount of federal student loans originated between 2005 and 2008. By 2009, the FFEL program's share had fallen to 69 percent, and to a mere 18 percent in 2010 as difficulties experienced by private lenders during the financial crisis and uncertain prospects for the guaranteed loan program led many schools to switch to the direct loan program. The student loan volume is estimated to be $1.4 trillion over the 2010 - 2020 period. Although the Education Department probably could have financed all the loans required by students in FY2010, some felt that such a rapid scale-up might cause problems, so the mandate to switch was set for July 1, 2010 (FY2011).

One of the most obvious changes is the servicing component. The DL program had been serviced by ACS, a division of Xerox. With the increase in loan volume now flowing through FSA, new servicers were needed. In June 2009, four contactors were selected to service the $550 billion portfolio and assume servicing responsibilities for all newly originated DL loans: AES/PHEAA; Great Lakes Education Loan Services; Nelnet Servicing, LLC; and Sallie Mae.

Low-income and minority students dependent on Pell grants are hit hardest in the student finance budget war.

Since staff at so many other loan services would be losing jobs, Congress authorized $25 million for 2009 and 2010 to help retrain and redeploy workers most affected by the recession. Only $19 million was applied for in 2010. The lenders, originators, and guarantors that worked under FFEL also lost a lot of business. Many quit or were forced to fold. The four servicers working under DL have now retooled. Sallie Mae is the only one still originating private loans. Nelnet, Great Lakes, and PHEAA are adding other business services geared for the higher education marketplace. All are actively improving their own offerings to borrowers and school customers, motivated by an incentive program.

The chosen service contractors went through an arduous procurement process. Initially, applicants had to be prequalified by having already serviced a significant volume of student loan assets, thus narrowing the field considerably. Only then did the formal bid process, requiring a lengthy and detailed Request for Proposal, begin. Finalists selected were just beginning what would be a six- to nine-month period of further review and onsite visits. One of the primary goals of this stringent due diligence was to determine if the would-be servicers could meet the onerous Federal Information Security Management Act (FISMA) cyber security standards.

The servicing firms would be awarded loans based on five performance metrics. Three metrics measure the satisfaction among separate customer groups, including borrowers, financial aid personnel, and student aid and other federal agency personnel who work with the servicers. The other two metrics measure the success of default prevention efforts as reflected by the percentage of borrowers and percentage of dollars in each servicer's portfolio that go into default.

Financial aid administrators are generally pleased with the new servicers. The ratings--which are posted to the Education Department's website quarterly--have been positive.

Indian Hills Community College (Iowa) was a direct lending school prior to SAFRA. Initially, Financial Aid Director Jo Altheide was skeptical of the changes coming as new servicers came on board, replacing ACS. "I thought it would be more detrimental than it actually was," she recalls, adding that "in the long run, it will be better for both students and [the institution]." She credits the servicers for taking suggestions to heart. During the transition, the new contractors were providing training for staff, assisting with exit and entrance counseling, and improving students' financial literacy.

U.S. Rep. George Miller (D-CA), author of the Student Aid and Fiscal Responsibility Act, agrees. "From all accounts, the move to full participation in the Direct Loan program is going exceptionally well. The program is working, as it has for the last two decades," he says. "Our decision to invest in students and eliminate wasteful subsidies to banks was the right one."

Many financial aid administrators felt like they had just recovered from a drubbing from Andrew Cuomo's investigations into student lending. Banks that had been following guidelines set by the Federal Family Education Loan program were painted as crooks. All aid administrators were tarred with the same brush as the handful who had crossed the line. The dust had barely settled, when the Education Department announced it would be discontinuing the FFEL program in place of a solely Direct Lending program.

Some administrators considered FFEL a religion and were mortified that it would end. Others were nonplussed. Regardless of feelings, the switch to DL would mean massive changes in practices and systems. To further complicate matters, institutions were caught between a rock and a hard place. Federal officials were issuing orders to convert systems and be ready to do business by July 1, 2010 in

anticipation of passage of the requisite legislation. Meanwhile, Congress was bickering and unable to get a bill through. Should schools risk the sizeable cost and enormous management energy to convert IT systems and business processes if the statute didn't pass--or risk being caught without access to Title IV funds if it did? The National Association of Student Financial Aid Administrators recommended going ahead with the conversion, and virtually all schools did.

Maureen "Mo" Amos, director of financial aid at Northeastern Illinois University, was one who charged ahead. "Administrators were forewarned of the change to direct lending along the same time as the 2008 presidential campaign, when all three Democratic, Republican, and Independent candidates were pro DL," she recalls. "I promptly began campus discussions and an implementation policy. NEIU would have been ready whenever the transition was required."

Ironically, many schools already on the DL program had more discomfort than those who converted to the DL system for the first time. The problem for old DL schools came in having to accommodate relationships with five servicing contractors instead of the one. ACS had been the sole provider up until this point.

The technical conversion went pretty smoothly. The Education Department provided assistance at the annual FSA Conference and via seminars, webinars, tech support, and site visits. Congress even budgeted $50 million for personal assistance for schools that could not manage. Much of it went unspent. Virtually all 4,400 institutions were online by July, or at least by the start of classes in the fall.

The University of North Florida was not a DL school. "I felt it was sudden," says Anissa Ange, director of financial aid. "The biggest challenge was no phase-in." Still, UNF launched early during its summer term. But there were complications. May was in the middle of an aid year (fall-spring-summer). Since the two summer terms straddled the July fiscal year start, there were two interest rates.

Under the direct lending program, students like these at Northeastern Illinois University will have a single servicer and be able to control their accounts with a single promissory note.

Most--but not all--schools managed. As recently as March of this year, University of the District of Columbia President Allen Sessoms admitted to still having problems managing disbursements and refunds. "We were among the ones who had trouble," he said in a radio interview. "We're catching up, and have dispersed more in the first week and a half of the semester than we did in the final four months of the previous semester. This is a job that the banks used to do; unfortunately, some of our staff simply weren't trained."

Experienced schools voluntarily helped new entrants, as well. Margaret Rodriguez is the senior associate director of financial aid at the University of Michigan. She's also the chair-elect of the National Direct Student Loan Coalition (NDSLC), which was started 12 years ago.

Prior to SAFRA, the coalition advocated for federal student aid and ways to make the DL program efficient. Since SAFRA, the coalition has mentored 1,000 schools. NDSLC still maintains an active listserv for information sharing, and mentors are available to assist colleagues in the business, financial aid, and IT offices. NDSLC also serves as the eyes and ears for the Education Department, identifying issues that need attention and providing guidance.

The incentive program, by which the servicers are allocated more loans, appears to be working. "My mailbox is inundated with offers," Altheide notes. "As servicers vie for their share, students will see more benefits. The business model is a good one. As for dealing with four servicers now, no problem. "It's like a town with five gas stations. Better than just one," she says.

Proponents of the conversion from FFEL to DL based their argument on the savings that would accrue to the government, and therefore to taxpayers. Some $68 billion over 10 years expected from SAFRA was earmarked to increase Pell grants and to contribute to deficit reduction.The government, like any bank, would expect to generate revenue based on the difference between the amount of the loans made, less the cost of the capital borrowed, less the servicing and administrative costs for managing the program. For example, if Citibank were making a single four-year car loan, that would be a simple calculation. For hundreds of billions of student loans spread out for decades, the math gets a little dicier.

The $68 billion number was based on Congressional Budget Office (CBO) projections of the cost of capital for the federal government. Typically, this is based on the tranche of three- to seven-year Treasury notes. At current rates, one might expect the cost of capital (interest paid on the T-notes) to be about 2 percent. If student borrowers are paying 6.8 percent, that would leave a spread of 4.8 percent, or 480 basis points. Even after deducting the cost of servicing and administrative fees, the margin would be pretty healthy, right?

Not so fast, say experts who have been involved in student lending for decades. Over a long period of time, the cost of borrowing will fluctuate. This will lower the margin or even create a negative spread. Further, other factors can--and will likely--impact the numbers.

Take, for instance, the concept of Income-Based Repayment (IBR), which is built into the SAFRA language. Upon graduation, the borrower will only have to repay the loan based on his ability to repay. Given the current economy, high unemployment, and downward salary pressure, the cash flow back to the government will be impeded. Add to that defaults, forbearance, loan forgiveness, collection costs, and so on, and the math gets worse.

According to those same pros, the Direct Lending program has lost money since its inception. Why would one expect it to make money starting in FY2010?

The CBO is already waffling on the $68 billion savings number. In a March 15, 2010 letter to ranking budget committee member Senator Judd Gregg (R-NH), director Douglas Elmendorf cited an additional $6 million in administrative costs over the president's budget, lowering the net savings to $62 billion.

Borrowing $100 billion for education has a deleterious effect on the whole U. S. government loan portfolio. Say it causes an incremental 3 basis points. Multiply the federal debt of $14 trillion by 3 basis points and it will easily wipe out any savings attributable to the DL program. When Congress moves to reduce the federal deficit in this or some future session, it will be looking for assets to sell. The student loan portfolio is more likely to be sold than some other hard asset like that nice white house at 1600 Pennsylvania Avenue.

Students at Indian Hills Community College should benefit as loan servicers battle to deliver on customer service incentives suchas smartphone technology and financial literacy instruction.

Moving forward, SAFRA changes will likely be incremental. New not-for-profit servicing organizations will create some competition for the Big Four. Only $100 million will be awarded to this group initially. Administrators can expect increased use of internet and smartphone technology, as well as more financial literacy tools for borrowers. Only one of the four servicers originates loans now. Sallie Mae is developing loan products aimed at reducing future debt. Its Smart Option Student Loan offers in-school interest payment options and shorter repayment periods. If a student selects the options to make interest or $25 monthly payments while in school, a typical freshman can save 30 to 50 percent in interest paid over the life of the loan and pay off the loan five to eight years faster. The typical loan repayment starts after graduation and the term is up to 15 years.

Because the incentive program makes awards on pristine default rates, all the servicers--and simultaneously schools--are placing significant emphasis on default reduction strategies. "Now is the time to assist students in repaying their loans," Michigan's Rodriguez says. "Many FFEL loans were purchased by the feds and the old FFEL lenders are retiring their portfolios. It is important to know who is holding those loans." Students also need to understand that the economy is tight. Their earning power will likely be impaired, affecting their ability to repay.

UNF's Ange notes another rarer, but time-consuming problem with servicing older FFEL loans. As banks leaving the program sold their loan assets during the ECASLA buyback, the servicing continuity was lost. It's difficult to find records or old promissory notes, a frustrating situation for alumni and institutions. By all accounts, the Education Department, servicers, and schools are all working diligently to have multiple loans serialized with a common servicer.

Financial aid administrators are now focused forward. NASFAA president and CEO Justin Draeger says the main concern on the minds of his association's members is future funding. The Education Department has to do its projections by February each year and notify schools what fund levels they'll be receiving. By March, schools had already sent out the acceptance letters and notified students of their aid packages. It took until April 15 to get a budget passed.


What would have happened if the funding didn't meet the projections and aid packages were overstated? Schools would have had three options: 1. Renege on the offer and start over. 2. Lower the offer. Many schools did include a caveat that the offer was contingent on the funding coming in as projected. 3. Buck up and stand by the offer regardless.

Ange is concerned about funding for the award packages she and her staff sent out in March. While Pell grants may survive intact, the Federal Supplemental Educational Opportunity Grants and state Florida Student Assistance Grants are not so certain. UNF is prepared to handle a shortfall. It has some reserves set aside.

In addition, the director, who usually commits 125 percent of what she expected to be used by students who actually matriculate, only committed 100 percent this year. If students do not enroll, she doubts that any excess created will be reallocated.

Pell was supposed to be a beneficiary of the SAFRA switcheroo. The $5,550 cap seems to have survived the last-minute April 15 budget battle, but the sour economy has made more students eligible. Fixing the funding, fixing the cap, and markedly increasing the base makes for poor institutional forecasting. There was Republican pressure to reduce Pell grants' maximum to $4,705, but it failed. While this may have seemed "mean-spirited," tying Pell to CPI, as was done in the SAFRA legislation, is encouraging (or at least enabling) highly undesirable tuition inflation.

The long-term FY2011 Congressional budget resolution maintains the $5,550 maximum Pell Grant for the 2011-12 award year and gives campuses the ability to offer eligible students a second Pell Grant award this summer.

However, the cuts do impact many large student aid programs for 2011-12, including the Federal Supplemental Educational Opportunity Grant and Federal Work Study. The bill calls for a 0.2 percent cut to all education programs across-the-board.

A serious fight is brewing in Congress over fiscal year 2012 spending levels for federal student aid programs. House Republicans have approved an FY2012 budget outline that would roll back 2012-13 Pell Grants to FY2008 levels. Department of Education data shows that this would result in 1.4 million students being denied Pell Grants. With lower Pell availability, more students will be borrowing, and borrowing more money.

While there are many positives inherent in the DL program, the bright promise of saving students and taxpayers billions remains to be seen.

Tom Robinson is a freelance writer specializing in higher education. He resides in St. Augustine, Fla., and Charleston, S.C.