July 11 (Bloomberg) -- Getting the money for a U.S. education, whether it's kindergarten or graduate school, increasingly depends on the bond market, where everyone from General Electric Co. to Goldman Sachs Group Inc. is rushing to meet record demand for student loans.

Soaring tuition costs are driving the boom in federally financed and private loans, 75 percent of which Wall Street transforms into debt securities. About $44 billion of bonds tied to student loans were sold in the first half of 2006, Moody's Investors Service says. At that rate, sales will top last year's record $73 billion.

``The bond market continues to support the spiraling cost of education,'' said Brent Griffith, an analyst with Fitch Ratings in New York. ``Clearly investor appetite is there.''

That's why GE, the world's second-largest company by market value, said last month it will start offering education financing. Goldman Sachs, working with billionaire Robert L. Johnson, has a similar plan to make student loans. The bonds are hot because they're coveted by lenders and investors alike for their relatively high yields and default protection.

Sales of student-loan backed securities grew almost five times as fast as the $1.97 trillion asset-backed bond market last year, according to the Bond Market Association, a New York-based trade group of dealers and underwriters. Bankers are packaging anything that resembles student debt, including loans for college, primary school, tutorials for casino dealers in California and yoga instructors in Iowa.

`Fill That Gap'

Some 8 million students will borrow $60 billion in federal student loans during the 2006 fiscal year, according to the U.S. Department of Education. In the prior year, $52.8 billion was borrowed by students, said the College Board, a New York-based non-profit organization that represents universities and other educational institutions.

The use of private loans to fund college costs has grown more than nine-fold during the last decade to $13.7 billion as of the 2004-2005 academic year, said the College Board. That makes it the fastest growing source of funds for students.

``The cost of education has been increasing significantly while the level of federal loans and grants has been fairly static,'' said Jack Kopnisky, chief executive officer of Boston- based First Marblehead Corp., which bundles debt into bonds. ``Private student loans fill that gap.''

The company last month reached a three-year agreement with a unit of Fairfield, Connecticut-based GE to make private student loans. GE will offer financing for students attending programs from kindergarten through graduate school, and will market the loans through the Internet and direct mail.

GE Loans

First Marblehead will combine the GE loans and sell bonds backed by their interest and principal payments.

Fitch provided credit ratings on a record $12.9 billion of planned student-loan bond sales in June, according to Griffith. The deals included five transactions of more than $1 billion and three larger than $2 billion.

Unlike other consumer debt, such as credit card balances, lenders and investors are protected in the event of default with student loans. Standard & Poor's said in a report that student- loan backed bonds have ``yet to see a single downgrade'' in ratings.

``You can wipe out credit card debt in bankruptcy, but student loans can't be discharged,'' said Juliet Jones, a New York-based analyst in the structured finance group at Barclays Capital, a unit of Britain's third-biggest bank.

The amount of outstanding bonds backed by student loans totaled $162.9 billion at the end of the first quarter, up from $3.5 billion in 1995, according to the Bond Market Association.

Beating Treasuries

Securities backed by student loans have become a bigger part of the asset-backed market, making up 8.3 percent at the end of March, compared with 1.2 percent in 1995. Home equity loans are the largest part of the market with 28.1 percent.

Student loan securities have returned 2.77 percent this year, compared with a loss of 1.03 percent for Treasuries, according to Merrill Lynch & Co. indexes.

``No one is going to get rich investing in student loan bonds,'' said Mark Adelson, head of the group at Nomura Securities International in New York that analyzes asset-backed securities. ``It's part of having a portfolio that reflects the broad market.''

Sales of bonds backed by student loans are growing faster than mortgage-backed bond sales, which increased 17 percent this year, according to Citigroup Inc. Only sales of credit-card bonds are increasing at a quicker rate, rising almost 90 percent to $35.8 billion.

At the Happy Valley School, a boarding school in Ojai, California, founded by ``Brave New World'' author Aldous Huxley, Paul Amadio is referring more parents to private loans if they can't afford the $35,200 tuition.

Bigger Chunk

``These parents are really boxed in,'' says Amadio, the school's head. Families earning between $80,000 and $120,000 are taking on debt for private education because it may help their kids land spots at top colleges. ``Paying this type of tuition is a hard sacrifice,'' he says.

For a family in the lowest income quartile, the cost to send a child to a private four-year institution during the 2003-2004 school year was 83 percent of their income, up from 60 percent in 1992-1993, according to the College Board.

After grant aid is subtracted, it still takes about one- third of that family's yearly budget to pay for a private institution, the report found.

Harvard University in Cambridge, Massachusetts, will charge $43,655 in tuition, fees and room and board for students going to the school in September, up 4.8 percent the year before and 32 percent from the 2000-2001 school year.

``The cost of education is skyrocketing and it's projected to keep increasing at double the rate of inflation,'' said Jones at Barclays.

Rate Comparison

Students in their first year of college can get a maximum of $2,625 with Stafford Loans, the main source of government- guaranteed funding for college students. The government guarantees repayment of as much as 97 percent of those loans.

Once students reach the cap, they may turn to the private loan market, which has higher rates and no government guarantees.

On July 1, the rate on government-backed student loans increased to 6.54 percent from 4.7 percent. That same day, Bank of America Corp. advertised a variable interest rate of 8.49 percent for one of its prepGATE programs, which provides funding for kindergarten through 12th grade.

In both cases, the loans can be sold to a trust that issues bonds, raising money so more loans can be made. As students repay their obligations, the proceeds are passed to bondholders.

Moving Back Home

Private-loan-backed bonds with a 10-year average life typically pay about 12 to 18 basis points more than the London interbank offered rate, a benchmark currently yielding 5.5 percent for three months, according to James Grady, a bond fund manager at Deutsche Asset Management in New York.

Those with government guaranteed loans offer about 10 to 11 basis points in extra yield over Libor, he said. The firm had $630 billion in assets under management at the end of 2005.

Erin Vondrak, 21, is starting her last year at the University of Redlands in Redlands, California, with 20 percent more in loans than she expected three years ago. Her fiancé, Thor Grant, is also saddled with debt. The two will live with his parents when they graduate to make ends meet.

``We need to make money and start paying off loans,'' said Vondrak, a multimedia design major whose tuition, room and board through four years will leave her about $25,000 in debt. ``Both can't happen quickly because of the other.''

Grant, who worked on campus to earn extra money, will finish school with about $120,000 in loans.

Sallie Mae

Bank of America and Wells Fargo & Co. are promoting private student loans on their Web sites. On June 28, Robert L. Johnson, the founder of Black Entertainment Television, formed a company with New York-based Goldman Sachs, the most profitable U.S. securities firm, to provide loans mainly for students attending colleges and universities in urban areas.

SLM Corp. of Reston, Virginia, chartered in 1973 by Congress as the Student Loan Marketing Association, gave up subsidies it enjoyed as a government-backed enterprise in 2004 so it could reap bigger profits from private lending.

The company, also known as Sallie Mae, says about 14 percent of its $127 billion of student loans lack government guarantees, up from 12 percent a year ago, according to Thomas Joyce, a spokesman.

Bartending, Poker Classes

Students enrolling at The National Schools in La Mesa, California, can finance classes in bartending and casino dealing through Sallie Mae. The bartending program costs $500 while a two-month course to learn how to deal poker, including Texas Hold-Em and 7 Card Stud, costs $895.

The Maharishi School of the Age of Enlightenment in Fairfield, Iowa, advises its students that they can take out a loan with Citigroup. It costs $2,500 to study transcendental meditation and loans can be repaid over as long as 10 years at an interest rate of prime plus 1.50 percent. The prime rate is currently 8.25 percent.

The sale of bonds backed by private loans is up almost 30 percent this year, to $7 billion, according to Moody's.

``Relative to government-guaranteed loans, private loans offer yield pick-up,'' said the Deutsche Asset Management's Grady. ``With traditional student loans you don't have to pay as much attention to who originated the loans due to the government guarantee. With private transactions you have to be more selective,'' analyzing who is making the loans, types and terms of loans, and the credit history of borrowers, he said.

On June 9, Sallie Mae sold $482 million of bonds with government guaranteed loans. The bonds have a weighted average life of three years and top AAA ratings from S&P, Moody's and Fitch. The yield on the bonds was 1 basis point less than the three-month Libor. A basis point is 0.01 percentage point.

No `History'

A day earlier, National Collegiate Student Loan Trust, which issues debt for First Marblehead, sold $190 million of bonds backed by private loans, with AAA ratings and a similar maturity. Those securities were priced at 3 basis points over one-month Libor, a benchmark borrowing rate currently at 5.36 percent.

``We haven't seen a lot of history'' with some types of the private loans, said Jones at Barclays.

When issuers have a limited history of performance, the ratings companies may require additional credit support to protect investors, Jones said. That support can include adding more loans to back the bonds and setting up reserve accounts.

Government Guarantee

The default rate on government-backed student loans ranges from 5 percent to 10 percent, said Fitch's Griffith. Bondholders aren't exposed to that much risk because of the government guarantee. The rate can be as much as 40 percent on some private loans, he said.

To assuage investor concern about defaults on private loans, universities sometimes provide guarantees.

The University of Pennsylvania guarantees some loans to undergraduates and provides partial guarantees to graduate students attending the University of Pennsylvania's Wharton School. Tuition and fees for Wharton's Master of Business Administration program in the 2005-2006 school year were $42,180.

Moody's last month rated a $42 million bond that includes loans to students of the University of Pennsylvania.

To contact the reporter on this story: Christine Richard in New York at Crichard5@bloomberg.net

Last Updated: July 11, 2006 10:25 EDT