Statement of June M. McCormack
Executive Vice President
Sallie Mae

Good morning Chairman McKeon, Ranking Member Kildee and Members of the Subcommittee, I am June McCormack, Executive Vice President at Sallie Mae. On behalf of more than 7,000 employees of Sallie Mae, thank you for the opportunity to talk with you about the federal student loan program, and, in particular, the loan consolidation program.

On a personal note, it is an honor for me to be here because nearly 20 years ago, one of my first jobs at Sallie Mae was building one of our earliest loan consolidation programs. Today, I manage a very different loan consolidation program for Sallie Mae. I would like to describe recent trends in loan consolidation and recommend some positive steps that Congress can take as part of reauthorization of the Higher Education Act (HEA). I know we share the same goal: To preserve a remarkably successful, stable and cost-effective student loan program that provides $50 billion each year to finance postsecondary education for students.

As described below, we support reform of the loan consolidation program in the upcoming HEA reauthorization. We are, however, particularly concerned about recent proposals that would permit reconsolidation of loans made to borrowers who have graduated, and who already received the benefit of taxpayer-subsidized below-market interest rates. The capacity of our nation’s financial aid system to ensure postsecondary access to all of the projected incoming low-income and minority students in coming years is jeopardized by such proposals which would shift taxpayer subsidies from students in school to borrowers in repayment. Moving in this direction also undermines the public/private partnership through which lenders invest private sector capital in support of one of the most successful government programs in history. Never before has the federal government retroactively changed the contract terms of student loans in a significant way after they have been made. This type of retroactive change creates new and real risk that increases the cost of financing and makes the prospect of investor-driven litigation likely.

The policy questions raised by this discussion are difficult and we appreciate the concerns raised by borrowers who consolidated at rates higher than the current market’s historically low rates. While we sympathize with their concerns, given today’s tight fiscal environment, policymakers will be asked to determine when should borrowers receive the benefits of taxpayer-subsidized below-market interest rates? When they are in school or after they have completed school and are better economically situated to repay their student loans? For example, if all current consolidation borrowers refinanced at today’s record low rates - and why wouldn’t they - the estimated cost to the government, and ultimately taxpayers, would be more than $15 billion.

Late last year, Sallie Mae joined the Consumer Bankers’ Association, the Education Finance Council, the Student Loan Servicing Alliance and the National Council of Higher Education Loan Programs in recommending to this Committee how the reauthorization of the HEA can strengthen the student loan program. A copy of these proposals is attached to my testimony. While there is not always unanimity among loan providers and schools, there is nearly total agreement among loan providers and schools that permitting reconsolidation or repealing the "single holder rule" would adversely impact the student loan program. Enacting such proposals would not provide access to a single new student. These proposals also threaten the ability of loan providers to continue to partner with the federal government in making billions of dollars in low-cost capital available each year to students and families to help pay for college. Repeal of the "single holder rule" will do nothing for the student loan program, or existing students, other than unleash an avalanche of spam, junk mail and telemarketers on unsuspecting borrowers.

Nearly 40 years ago, Congress created one of the most successful federal programs in our nation’s history – the federal student loan program. Thirty years ago, Congress created Sallie Mae to help make equal access to higher education opportunity a reality. Sallie Mae’s mission was to build a stable market where none existed by encouraging private sector loan providers to offer student loans and thereby open the doors of college to millions of students. Thanks to the leadership and vision of a succession of Congresses and Administrations, student loans are available today to any student or family, without a credit check or collateral, so that no child is turned away from higher education based solely on the financial status of his or her family. That entitlement is central to the American Dream. It is the envy of other nations.

We are part of a unique public-private partnership -- the Federal Family Education Loan Program, commonly known as FFELP. Last year, loan providers made $50 billion in private capital available in the form of student loans to over five million students and their families at more than 6,000 postsecondary institutions across the nation. The federal government also makes student loans through the Federal Direct Loan Program (FDLP).

The federal student loan program is an unparalleled success story of which Congress should be proud. Since 1965, more than 50 million students have gone to college, in part, thanks to federal student loans. Each year, lenders provide more capital to students, yet the total cost of the FFEL program has declined. Last year, FFELP spending accounted for less than 1/10^th of 1 percent of the government’s annual $2 trillion in spending. In fact, last year, the federal government spent less than one penny for every outstanding student loan dollar. Equally impressive is the fact that over the past 10 years, entitlement spending increased by 33% while spending on FFELP decreased by 83%. These cost savings are due to the efforts of loan providers, in partnership with Congress and schools, to reduce defaults, increase collections of defaulted loans and reduce costs for interest and other expenses.

Sallie Mae is the nation’s leading private sector provider of higher education financing with over $83 billion in student loans and more than seven million customers. We take our responsibilities to students, families, schools and taxpayers under the Higher Education Act very seriously. As the original – and, at the beginning – the only provider of consolidation loans, we are proud to be the number one provider of consolidation loans to borrowers today. Last year, we helped more than 312,000 borrowers consolidate nearly $10 billion in federally guaranteed student loans.

The student loan program is successful because, in an era of limited government resources and rising college costs, America’s student loan providers use private capital to invest millions of dollars in services and systems that directly benefit students, their families and schools. This year, Sallie Mae alone will invest more than $150 million in technology support for the student loan program. In recent years, loan providers have developed Internet-based services that provide fast, reliable services for borrowers. Thanks to these investments, students can now receive their loans on the same day they apply – all at the click of a mouse. Only a few years ago, this same process took weeks. Loan providers are also adding web-based tools and services every year that allow students to quickly and easily estimate their college costs, compare repayment options, check their loan status, learn about managing debt and obtain information on debt counseling.

Schools also benefit from investments made by loan providers. For example, we offer financial aid delivery tools to schools that allow them to originate loans quickly and with less paper, answer questions from parents and students, provide one-stop service for students, and give schools greater access to, and control of, loan information. We also complement the efforts of financial aid officers and high school guidance counselors to promote the availability of financial aid by answering millions of calls from parents and students about the financial aid process. We help reduce the cost of college by offering borrower benefits and interest reductions for on-time payment. Finally, we are answering the growing demand for private credit that helps bridge the gap between financial aid sources (including federal loan programs) and available family resources.

So how does this type of private sector investment help real people? It means that if a parent is filling out their financial aid forms and gets stumped on how to answer a question, they can call Sallie Mae’s "Parent Answer" line and we will help them. Or if a student decides to enroll at the last minute, thanks to our investment in technology, he or she can have a student loan processed in minutes. It also means that we work with borrowers to help keep them on-time and in repayment, thereby avoiding the consequences and costs of default.

Our ability to invest in our nation’s financial aid system is made possible by the historic stability in the federal student loan program that Congress has carefully managed. Proposals to fundamentally alter the student loan program – some even retroactively – not only threaten our ability to make future investments, but will depress the innovation that has made the student loan program the success that it is today.

In 1981, Sallie Mae proposed, and Congress enacted, an amendment to the Sallie Mae charter to permit development of a loan consolidation program. The original purpose of the program was to help solve problems faced by an increasing number of borrowers whose loans were "split" between different loan providers. At that time, students who did not accurately navigate changes in their borrower status faced administrative confusion and red tape (requesting deferments from 3 or 4 different lenders and writing 3 or 4 checks a month), and in some cases, even ended up in technical default.

From the beginning, loan consolidation was designed to prevent defaults and simplify repayments. It was never intended to be a refinancing vehicle. In fact, consolidation loans for the earliest borrowers carried an interest rate that was the weighted average of their original loans, rounded up to the nearest whole percent. By offering borrowers the administrative convenience of making a single monthly payment to a single loan provider, policymakers believed that they could reduce the incidence of borrowers defaulting simply because they were unable to keep track of their original loans. Consolidation also provided borrowers with the opportunity to reduce monthly payments by extending their repayment period over a longer period of time. In 1986, responding to requests of other loan providers, Congress authorized all other loan providers to make consolidation loans.

Sallie Mae has an excellent record of advising our customers about consolidation. When interest rates were higher, we discouraged consolidation unless a borrower needed to stretch out his or her payments. As interest rates plummeted and consumers started using consolidation as a refinancing vehicle, Sallie Mae made all of its customers aware of historically low interest rates, running national education campaigns.

So, how did consolidation become a refinancing program? The seeds were sewn when Congress shifted student loans from fixed to variable rates in 1992 and neglected to make a parallel change in consolidation loans. As a result, while all student loans made after 1992 have variable rates that reset annually based upon 3-month Treasury bill rates, consolidation loans have fixed rates, which lock-in the very same 3-month Treasury bill rate for up to 30 years. Simply put, today’s consolidation borrower is taking out a long-term loan based on short-term rates – an enormous interest rate risk that is borne by taxpayers. In fact, this formula allows a borrower today to pay a rate of interest that is below the United States Treasury’s long-term cost of funds.

Consolidation Rates Are Below Federal Borrowing Costs

Granting every borrower the opportunity to borrow at rates well below where even the Federal Treasury borrows will drive up the cost of the student loan program. Most of the additional federal cost will go to benefit borrowers who have received post-graduate training.

While many of our consolidation borrowers have smaller balances (Sallie Mae’s minimum balance for consolidation is below that of most major consolidation marketers), the majority of our consolidation volume is in higher balance, longer-term loans. Fifty percent of our consolidation loan volume is made up of loans with balances in excess of $40,000 that will be paid back over 25 years or more. Eighty percent of our consolidation loan volume is made up of loans with balances in excess of $20,000.

This distribution has significant implications for cost, because taxpayers will continue to pay the difference between the below-market, subsidized borrower rate and current market interest rates for the entire life of these loans. Comparing who benefits from the additional taxpayer cost, we see that over 60 percent of federal subsidies will go to borrowers with balances greater than $40,000—there are very few undergraduates at this level. Less than 13 percent of the additional consolidation subsidies will go to the typical college graduate, who can only exceed $20,000 if they are independent (generally, over 24 years old) or borrowed at the maximum for five years or more.

Reconsolidation

As interest rates have declined, borrowers who already exercised their consolidation benefit have understandably raised their hand to complain that they are not eligible to consolidate now to take advantage of the much lower current rates. Quite reasonably, they are asking, if I can refinance my home, why can’t I refinance my student loan, too?

On its face, this argument makes perfect sense. And we are sympathetic to those who have locked in at higher rates. The reality is that this argument ignores the enormous differences between student loans and home mortgages.

First, a home mortgage can be refinanced at the will of the homeowner, and therefore there is a high probability that the borrower will pay off the loan early. This prepayment risk is built into the cost of that mortgage. The pricing on a student loan asset, on the other hand, is set by federal law, and makes no provision for multiple refinancings. Under the terms of today’s program, a borrower is permitted to consolidate his or her loan only once.

There are other fundamental differences between consolidation loans and home mortgages. For example:

Homeowners put their homes up as collateral for their mortgages.

Consolidation borrowers put no collateral at risk.

Homeowners pay points and fees to mortgage lenders to refinance their mortgages.

Consolidation borrowers pay nothing – the federal government and lenders absorb all costs.

The rate of interest on a mortgage varies daily, is set by the market, and varies widely depending upon an individual’s credit history and the term of the loan.

The interest rate on a consolidation loan is set by Congress using short-term rates and is determined in exactly the same manner for every borrower, irrespective of credit history.

Key differences are highlighted in the table attached to my prepared testimony.

We oppose reconsolidation for three other key reasons - cost, precedent and program stability.

Cost: While we feel an obligation to educate our customers about historic rates, we believe that the long-term price tag of extending this benefit to all borrowers all the time must be considered.

For example, during the first three-quarters of the 2002-2003 academic year, about $28 billion in FFELP loans were consolidated. These new consolidation loans will cost the federal government an additional $4 billion over the life of the loans. An additional one-time consolidation by all loan holders who consolidated prior to this month’s reset, and they all have rates above the current ones, would cost the government more than $15 billion as interest rates return to historic averages. Even at more moderate interest rate levels, the cost of these consolidation subsidies will dwarf the cost of the underlying FFEL program.

By not addressing the issues in the current consolidation program and/or by permitting reconsolidation, Congress is providing a costly new benefit – in the form of new repayment subsidies – to borrowers who have already completed their education and are in the workforce. It makes little sense to heavily needs-test the financial aid program on the front-end and then confer deep back-end subsidies regardless of borrower need. It also invites questions of fairness for those borrowers who are not fortunate enough to take advantage of historically low rates today. Will these borrowers also be granted the ability to lock-in below-market interest rates as low at 2.82%? Consolidation could become the giant that swallowed the student loan program.

Precedent: Most lenders enter into hedging agreements and securitize their loans to raise funds for future loans. Recognizing that lenders have legally binding contracts as part of the student loan program, Congress has never significantly changed the terms of student loans retroactively. Permitting retroactive reconsolidation of loans that have been financed through securitization transactions would fundamentally alter contracts between loan providers and investors after the contracts were made. If Congress breaks the terms of existing contracts, a level of uncertainty will be introduced into the program and make the prospect of investor-driven litigation likely. Congress will be sending a clear message that loan terms could change at any future point. The cost of this uncertainty will have to be built into every future loan – Stafford as well as consolidation.

Program stability: Understanding loan securitization is critical to appreciating the challenges loan providers would face if Congress authorizes borrowers to reconsolidate their already consolidated loans. Loan securitization is the principal means of making private sector capital available for students and families to help them pay for college. After a student loan is made, most large loan providers finance their portfolios of student loans through asset securitization to free up capital and make more student loans to new students. The end result of these transactions is that more capital is available to make higher education possible for more students who need to borrow money to pursue higher education. The loan provider continues to maintain the customer relationship with borrowers and retains certain residual cash flows from securitization trusts. The stable terms and predictable loan performance of student loans enable lenders to This efficient and accessible capital helps to facilitate thepass on low funding costs to borrowers in the form ofing of reductions in up-front fees and interest rates, as well as other benefits that save millions of borrowers hundreds of dollars each. Most importantly, securitization frees up funds for loans that ultimately make higher education possible for more students.

Lenders securitize student loans, and investors invest in securities backed by student loan assets, based upon the statutory terms of loans, including the prohibition on reconsolidation. If Congress were to retroactively change the contract terms of loans, investors would be faced with a level of risk that would be impossible to quantify. From Sallie Mae’s perspective, such a change could also delay the Congressionally-mandated privatization of our Government-Sponsored Enterprise (GSE). Enacting a reconsolidation proposal would retroactively alter the terms of loan contracts, destabilize the securitization marketplace and shrink the amount of capital available to lenders in the future.

The Single Holder Rule

Under current law, a borrower whose FFELP loans are held by a single loan provider must initially request consolidation from that same provider. If their loan provider declines to provide a consolidation loan, or declines to provide a consolidation loan with an income-sensitive repayment schedule, they can apply for a consolidation loan from another loan provider. Borrowers with loans that are held by more than one loan provider may consolidate with any eligible loan provider. This provision, referred to as the "single holder rule," ensures that lenders’ portfolios are not cherry-picked and protects "borrowers from mass marketing or selective marketing of consolidation loans." (Conf. Rept. 105-750)

Why does this matter? The financial aid community and Congress depend on us to provide capital, pay up-front fees, and pay for the technology network that processes loans and data within seconds. All of these investments are made by loan providers four years before the average student makes the first payment. As with reconsolidation, if a loan provider’s student loan asset is subject to poaching by another lender, there will be little incentive for loan providers to invest in the financial aid delivery systems that directly benefit schools or lower the cost of borrowing for students. Without the single holder rule, lenders would be incented to be only in the consolidation business, not the student loan business.

Although some argue that the single holder rule should be repealed, Congress’ concern that borrowers be protected from predatory telemarketing efforts, reflected in the 1998 Conference Report, has turned out to be prophetic. A few companies and telemarketing firms that are involved in the loan consolidation market are aggressively urging Congress to dramatically restructure the student loan program. These companies engage in repeated mass solicitations of these prospects. Repealing the single holder rule is a solution in search of a problem. Any borrower who wants to consolidate their student loans today can do so. And since the interest rate is set by statute, all lenders offer the same rate. While this proposal is being promoted as a consumer choice issue, FFELP borrowers exercise their consumer choices right at the time they borrow their their thetheirStafford or PLUS loans. Elimination of the single holder rule could result in aggressive marketing by non-lenders to borrowers without full disclosure of the benefits and risks of consolidation.

Late last year, Sallie Mae joined with the Consumer Bankers Association, the Education Finance Council, the Secondary Loan Servicing Alliance and the National Council of Higher Education Loan Programs and submitted several recommendations to this Committee about ways to strengthen the loan consolidation program as part of HEA reauthorization. I will quickly summarize these recommendations as they relate to the consolidation program. Again, a copy of our complete recommendations is attached to my testimony.

Congress has never retroactively significantly changed the terms of existing student loans. Any proposal that seeks to retroactively alter the terms of existing loan contracts must be rejected. Setting aside economics, changing the terms of pre-existing loans would telegraph a message of program instability. It raises more questions: What other terms will Congress change retroactively? How can loan providers make loans under the cloud that Congress could change the loan terms at any time or for any reason?

As you know, financial markets do not react well to instability. The net effect of instability in the financial markets is that the cost of capital goes up. Changing the terms of loans retroactively would seriously undermine long-term private investment in the FFELP and puts at risk the $250 billion in private-sector capital that has already been invested in financing the higher education of millions of borrowers.

If Congress chooses to provide relief to borrowers who have previously consolidated, it is critical that any solution to this matter be addressed outside of existing student loan contracts. In other words, if Congress determines that some consolidation borrowers should be relieved of their repayment obligations, the mechanism for providing this new subsidy should be payable to the borrower outside of the student loan contract.

America’s student loan program is a remarkably successful public-private partnership that has helped make college possible for more than 50 million students. In evaluating the merits of changing the terms of this partnership, we believe that there are three fundamental questions that must be asked.

First, will the proposed change increase access to higher education?

Second, what is the cost to taxpayers of the proposed change?

Finally, will the proposed change strengthen the successful public-private partnership embodied by the federal student loan program?

We believe that the consolidation program is in need of fundamental reform and that any savings that result from such reform should be spent on improving access to all students. We oppose proposals that permit reconsolidation or repeal the single holder rule, as they not only fail to improve college access, but they seriously undermine future access by introducing substantial new long-term costs to the student loan program.

Thank you for the opportunity to talk with you today. I would be pleased to answer any questions you may have.

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