Big Lender Pulling Out of State Student-Loan Program

California’s largest and most controversial maker of government-guaranteed student loans announced that it is pulling out of the program, throwing into further disarray California’s already chaotic student-loan market.

The lender, First Independent Trust Co. of Sacramento, which has made $1.5 billion in student loans nationwide since 1980, cited recent financial turmoil in the state’s $6-billion student-loan market as the reason for its decision. That turmoil, it said, includes the drying up of money in the “secondary market” where lenders sell the student loans.

What First Independent Trust did not mention in its announcement late Monday was that it has been given formal notice that it is about to be banned by state officials from making government-guaranteed student loans in California. The officials are alleging widespread and continuing violations by the trust company of student-loan program rules. It would be the first time a lender has been banned from making student loans, officials said.

State officials said they have found that First Independent Trust failed to pay at least $4.5 million in fees owed to the federal government during the first six months of last year and another $1.25 million in refunds owed to investors holding student loans.

“We are not talking about nit-picky things. We are talking about paying your bills when you are supposed to pay them and making your refunds when you are supposed to refund them. And we are talking about millions of dollars,” said Samuel Kipp III, executive director of the California Student Aid Commission, a state agency that administers federal student-loan programs.

But Jon D. Smock, a lawyer for First Independent Trust, said the company’s decision to withdraw from making student loans is not related to the state action.

He said the trust company disputes the state findings about its operations and plans to appeal the state’s move to ban it from making student loans in the future. Smock said that as a result of First Independent’s decision, about 4,000 students will have to look elsewhere for their loans.

Late Tuesday, the Higher Education Assistance Foundation, a private nonprofit group in Minnesota that guarantees student loans nationwide, said it will stop guaranteeing student loans made by First Independent Trust. The foundation guaranteed about 60% of First Independent’s student loans, nearly all of them made to students out of state.

First Independent Trust’s action is the latest mess for the government-guaranteed student-loan market. The problems started when an Encino company, United Education & Software, failed to properly “service” more than $1 billion in student loans.

Last year, federal officials reviewed United Education’s servicing operation and found the biggest foul-up ever in the history of the program. It included failing to send out thousands of letters to delinquent borrowers, sending letters to wrong addresses and stuffing hundreds of drawers full of documents waiting to be filed.

Because of those problems, U.S. Department of Education officials have decided that the government will not pick up the bill when students default on their loans. That has left on the hook some of the world’s biggest banks, most of them based in Japan, which backed with letters of credit the bonds that were issued to buy the student loans from various lenders.

Last month, nine of those banks sued Bank of America, trustee for the bonds, alleging that they have lost more than $350 million in the fiasco and may lose up to $650 million.

First Independent Trust has been California’s largest student-loan lender in the past three years and among the top five nationwide. As it has grown, the company has become increasingly controversial.

The company’s aggressiveness in making student loans, primarily to vocational school students who have the highest default rate of any student group, has made some state and federal student-loan officials increasingly uncomfortable.

One source of controversy has been First Independent Trust’s supplying of computer equipment linking vocational schools with its offices.

The company contends that that was done for convenience, but federal officials have said they consider it a way of inducing schools to send students for loans to the trust company and told First Independent to start charging for the equipment.

State officials said Tuesday that the company has not properly documented that it is charging for the equipment. However, Smock said this problem has been resolved.