Loan crisis goes to college

Paying for college could get even tougher this year as smaller lenders tighten standards and raise rates. But big banks are holding the line.


NEW YORK (CNNMoney.com) -- The credit crunch is hitting the college classroom.

When parents and students try to line up college funding this spring, they will likely be in for a nasty shock. They may still get a loan, but it will come at a price. Borrowers will have a more limited choice of lenders and find discounts for on-time payments or direct debit scarce. On top of that, they'll see higher rates and fees.

The credit crisis, which started last year with mortgages and has bled into many other areas, is now affecting student loans. Many lenders, particularly smaller companies not affiliated with banks, are finding their main source of funding for private student loans cut off as investors balk at buying securities backed by these loans. This will force some to boost interest rates on private loans by up to 1 percentage point, raise minimum credit scores to 650 and require parents to co-sign the loans, experts said.

"If lenders are not able to securitize, they are not getting the capital to make new loans," said Mark Kantrowitz, who runs FinAid.org, a college funding Website based in Cranberry Township, Pa. "It's an issue of liquidity and cost of capital."

On top of this, legislative changes enacted by Congress last year have sent some lenders fleeing from the federal student loan program. Lawmakers reduced the subsidy lenders receive for making government-backed loans.

While the interest rates on federal loans are set annually by the government, many lenders will stop waiving origination fees and cut out the discounts offered borrowers after they start repaying the loan, boosting the overall cost.

Private loan problems

With little or no profit to be made in the federal loan arena, some smaller lenders are exiting the business, while others are shifting their focus to the more lucrative private loan industry. Others, however, are curtailing even their private loan originations.

San Diego-based College Loan Corp., the eighth largest federal loan originator in 2006, recently announced it would stop making these loans as of March 1, though it will continue originating private loans. Lincoln, Neb.-based Nelnet Inc. (NNI) last month issued a statement saying it would "be more selective" in the loans it originates as it lays off 300 people, or 10 percent of its workforce. And on Tuesday, the Michigan Higher Education Student Loan Authority said it would stop making private loans, known as MI-LOAN.

"It's an area of concern, both in terms of the number of players and the cost of loans that students have to pay," said Tom Joyce, a spokesman for Reston, Va.-based Sallie Mae, the nation's largest lender formally known as SLM Corp (SLM, Fortune 500).

As college costs skyrocket, a growing number of parents and students rely on private loans to cover the gap between tuition and federal loans, which are limited to between $3,500 and $5,500 a year. Private loans made up 24% of education borrowing in 2006-07, up from 6% a decade earlier, according to the College Board, a New York City-based nonprofit higher education access group.

These loans, however, are much more expensive than their government-backed peers and will become even more so. For 2008-09, students will pay a fixed 6.0% on a subsidized federal loan, while the rates on private loans are as high as 13%, depending on the borrower's credit profile, and are inching upward, according to Kantrowitz. Rates on private loans change quarterly or annually, and two-thirds of borrowers pay the highest rate, he said.

"Most students will be able to get them, but they will have to be careful," said Sandy Baum, senior policy analyst at the College Board. "There will be an even greater risk of high interest rates and unfavorable terms."

Higher margins, more interest

While costlier for borrowers, the higher margins on private loans are attracting more lenders with the wherewithal to make these loans.

Private loans, for instance, made up 31% of Sallie Mae's $25.5 billion in originations in 2007, up from 20% five years earlier. The company, which suffered recently after a buyout by J.C. Flowers failed, is close to securing $35 billion in financing to carry it through the next school year. It plans to focus on the higher-margin private loan market.

JPMorgan Chase (JPM, Fortune 500) said the recent wave of failed auctions for investments backed by student loans won't affect its operations. The bank keeps its loans on its books so it is not affected by the securitization freeze. Like other big banks, Chase is not planning to raise its rates.

Chase is actually expanding its student loan operations because it has low defaults and puts the bank in touch with young people to whom they can pitch other products. In the fall it hired 140 people from struggling Nelnet and continues to add to the staff.

Blue chips that can ride out a recession

Solid stocks have been dragged down along with troubled shares. Learn to spot the bargains.

(Money Magazine) -- Really bad stock markets knock down shares of all kinds. That's essentially what has been happening since the start of 2008, as subprime fallout led to recession anxiety. But not every market sector faces the same problems and uncertainties.

Even if we are in a downturn, many companies will come through with their long-term prospects untarnished. Scoop up such stocks while their prices are depressed, and you have a real chance to boost your returns.

The way I see it, the stock market now is actually three markets. First, there are companies that depend on borrowing and lending, including home builders and makers of big-ticket consumer items that typically require financing, as well as bank stocks. Their shares all posted double-digit losses last year.

Yes, the stocks are starting to look like bargains, and the Fed's aggressive interest-rate cutting should eventually spark a recovery. But I'd be worried about buying in too early: The final chapter of the subprime story isn't written yet.

At the other extreme, inflation-sensitive sectors, such as energy and other commodities, have boomed for several years running. But they've had sizable losses so far in 2008, they're still relatively expensive, and they could stay down for a while if demand for raw materials falls in a slowing economy.

Finding the best deals
That still leaves a big swath of stocks whose share prices are down but which are unlikely to suffer lasting damage from the subprime flu or any mild cold the economy catches. The industrial, technology and consumer sectors all fall into this category.

In particular, companies that derive a large percentage of their earnings from outside the U.S. have the best chance of riding out a bad domestic economy. For example, two of the stocks I recommended in last month's column - Hewlett-Packard (HPQ, Fortune 500) and 3M (MMM, Fortune 500) - get at least 60% of their sales abroad.

Spotting true bargains during this downturn is no layup, though. Price/earnings ratios based on anticipated results may be misleading, for instance, because growth may not come through as expected this year. So make sure that a stock also looks cheap compared with its peers based on P/Es using 2007 earnings.

Another smart way to compare stocks is by ratios of price to cash flow (the cash per share a company actually generates each year). The reason: Cash figures tend to be less volatile than earnings.

Three stocks to watch
In doing a little bargain hunting among stocks in the Sivy 70, I found three that have solid prospects, trade at P/Es below 15 based on 2007 earnings and are priced at less than 10 times cash flow. Those multiples count as cheap by anyone's calculations.

DuPont (DD, Fortune 500) announced 27% earnings per share growth (excluding one-time items) in the fourth quarter and recently raised its earnings targets for 2008. How does a company in a cyclical industry such as chemicals buck a U.S. recession? Almost two-thirds of sales come from overseas, where they are growing up to 20% a year in countries such as Brazil, China and India.

The hottest part of DuPont's business has been agricultural products, boosted by rising food prices and demand for ethanol. That division, which accounts for almost a quarter of sales, is growing twice as fast as the rest of the company. As an added bonus, DuPont shares yield a very healthy 3.8%, making them a great choice for retirees.

Fortune Brands (FO, Fortune 500) is a conglomerate with top-name consumer brands, including Jim Beam bourbon and Titleist golf balls. The company also has a home and hardware division, which consists of product lines like Moen faucets. Those businesses have been suffering because of the bad housing market. As a result, the stock has fallen close to a 52-week low of $66, down from a high of $90. That looks like too much punishment for limited housing exposure. Besides, Fortune is restructuring to trim costs, downsizing its home and hardware division and selling its wine business. As a result, the company took a large write-down in the fourth quarter.

But long-term growth has averaged 9% annually and is projected to continue at that rate over the next five years. Add in the stock's solid 2.6% yield, and you have double-digit return potential.

IBM (IBM, Fortune 500) reported terrific fourth-quarter results. Earnings per share were up more than 20% on a 10% rise in sales. A third of the increase in per-share profits was the result of 2007 stock buybacks totaling almost $19 billion. The rest of the profit gain was mostly from IBM's extensive business outside the U.S., which now accounts for almost two-thirds of total sales.

The company is enjoying especially strong growth in Asia and some developing markets. Bookings for service contracts in 2008 are also several billion dollars above expectations, and IBM has raised earnings projections for 2008. As Big Blue goes global, seems like it would deserve a market-beating multiple.