$96 Million Reserved for Settlement : Student Loan Fiasco May Slash BankAmerica Profit

BankAmerica has reserved close to $100 million for potential losses in connection with a little-noticed scandal involving federally guaranteed student loans, a source at the San Francisco banking company acknowledged Wednesday.

In the fourth quarter of 1988, the bank set aside $96 million to cover what it identified as the expected costs of future legal settlements. A bank official, who spoke on the condition that his name not be published, said virtually all of the money is earmarked for possible losses related to the bank’s role as trustee for notes backed by about $1 billion in student loans.

The potential loss facing the nation’s third-largest banking company--the parent of Bank of America--illustrates an obscure danger in the student loan guarantee program.

Largest Case to Date

For the federal government to pick up the tab for loans that are not repaid, lenders must prove that diligent, specific efforts were made to collect the money. The government can refuse to honor its guarantee if there is an inadequate collection effort.

A spokesman in Washington for the U.S. Department of Education, which sponsors the loan guarantee program, said the amounts involved represent the largest case to date in which the department has threatened to withhold guarantees.

The BankAmerica example involves $1 billion in loans made by various financial institutions to students, chiefly at vocational schools. The lenders typically had sold the loans to the nonprofit California Student Loan Finance Corp. in Los Angeles.

Inadequate Collection Effort

To pay for the loans, the finance corporation sold notes on the secondary market. Investors like them because they are tax-free and backed by federal guarantees.

As trustee, BankAmerica was required to make sure that the noteholders received their interest and principal. BankAmerica also arranged letters of credit from major Japanese and U.S. banks, which provided a credit that could be drawn on until the loans were repaid or the federal guarantee came in on defaulted loans.

United Education & Software, an Encino company, was hired to service the loans, meaning that it was responsible for monitoring the payments and going after people who were delinquent.

Last summer, an examination of United Education by the federal government uncovered flaws in the firm’s compliance with collection guidelines on thousands of defaulted loans.

The examination came after the California Student Aid Commission, which administers the federal guarantee program in the state, rejected several thousand claims on delinquent loans submitted by United Education because collection efforts were inadequately documented, said Dan Parker, a spokesman for the commission.

The Encino company, which also runs vocationals schools, blamed the problem on a computer foul-up. Ultimately, it disposed of its loan-servicing business to settle the dispute that resulted with BankAmerica and the nonprofit finance corporation. Another company was then hired to service the loans.

However, the U.S. Department of Education has refused to honor its guarantees on millions of dollars in loans because the government says collection efforts at United Education were inadequate.

BankAmerica has been negotiating since last summer in an attempt to persuade the department to reimburse at least part of the losses. Unless a compromise is reached, the bank acknowledged last month, “a substantial segment” of the loans would not be covered by the federal guarantee.

The bank did not disclose the amount of delinquent loans for which the guarantees are in doubt. One non-bank official close to the talks said the figure is a central issue in the talks and that it could surpass the $96 million the bank has set aside as a reserve.

Peter S. Magnani, a bank spokesman, said the negotiations are continuing and that the bank believes it has fulfilled its obligations as trustee.

Parker said his agency, which is participating in the settlement talks, wants to ensure that the integrity of the student loan program is protected by any compromise.

In a footnote to its fourth-quarter earnings statement issued last month, however, the bank acknowledged that it has been threatened with lawsuits from the other big banks that provided the lines of credit if they suffer losses.

Among the banks are New York’s Citicorp, the biggest U.S. bank, and two of Japan’s largest banks, Mitsubishi and Dai-Ichi Kangyo. Barron’s magazine reported last month that Japanese banks have grown wary of financing U.S. student loans as a result of the problems associated with the BankAmerica case.