After months of financial and personnel setbacks, including state and federal investigations over auction rate securities sales, dismal earnings and the ouster of CEO Ken Thompson, Wachovia Corp. has another issue to weather. As of the close of business on August 7, 2008 the North Carolina-based bank officially stopped accepting applications for private, undergraduate student loans.
Private student loans are considered more profitable for banks over federal student loans based on the higher interest rates they carry. At the same time, private loans have greater risks, because there is no guarantee by the government. Wachovia says it will continue to offer education loans for graduate and professional students, in addition to education loans backed by the federal government.
In recent months, the ongoing credit crunch has prompted a number of lenders to drop out of the business of making student loans. Many student loan companies raise capital by selling auction rate securities, but in February, as fallout from the subprime crisis hit a boiling point, the market for auction securities seized up, making it extremely difficult, if not impossible, for lenders to secure financing for the loans.
Compounding the problem for student lenders is last year’s change to a federal law, which cut interest rates on government-backed loans and drastically reduced the subsidies that lenders make as a profit on student loans. As of March 2008, approximately 100 lenders had suspended their government backed student loan programs, with about 30 others leaving the private student lending business altogether.
In May of 2008, the federal government took steps to bolster the student loan market with the Ensuring Continued Access to Student Loans Act, which was signed into law on May 7, 2008. Among other things, the Act allows the U.S. Department of Education to buy government-backed loans from student lenders, thereby providing them with additional capital to finance new loans.
Meanwhile, Wachovia potentially has an even bigger issue to face. In July, its securities division was raided by a team of regulators from more than five states as part of a probe into the company’s sales of auction-rate bonds. With news that Citigroup, Merrill Lynch and now UBS agreeing to settle claims of deceiving investors about the liquidity risks of the securities by buying back their auction rate investments, Wachovia could be inclined to follow suit.
At the same time, however, Wachovia is looking at long-term credit problems and losses connected to its high concentration of option adjustable-rate mortgages and other risky investments. Any move to buy back the illiquid auction securities it sold to individual investors could very well put its balance sheets in serious peril.
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