Skip to main content

Sallie Mae - JC Flowers deserves a better deal

The student loan industry is resigned to disappointment. President Bush signed a bill today that cuts subsidies and increases grants. The bill will reduce profitability at all student loan lenders. It is a prime reason why the buy-out of Sallie Mae (SLM) by a group led by JC Flowers is facing rocky times. The terms of the deal were set at a time when funding for buy-outs was easily obtained and investors were more willing to accept riskier deals. The increased risk due to this bill and today’s credit market situation where investors are demanding higher risk premiums has put this deal in jeopardy. I agree with JC Flowers -- they deserve a better deal.

How the bill affects student lending

One of the ways lenders make money is through the subsidies paid by the U.S. Education Department on subsidized loans in the Federal Family Educational Loan (FFEL) program. The FFEL program consists of Stafford and PLUS loans. Stafford loans are the first ones financial aid administrators advise students to obtain; therefore, they are probably the most popular type of student loan at schools not in the direct lending program. Stafford and PLUS loans are a huge portion of every lenders portfolio so reducing the amount the government will pay essentially reduces the lender’s margin on each subsidized loan. The subsidies are based on aggregate amount of borrower interest accrued during certain periods in the life of the loans in the loan portfolio. It is expected that subsidies will be reduced by about $20 billion per year. By way of comparison, in 2006 there were about $23.3 billion in subsidized Stafford loans issued, $23.8 billion in unsubsidized Stafford loans and $8.3 billion in PLUS loans. There is close to $600 billion dollars in FFELP loans that have been issued since 1966.

Equally if not more troublesome is the fact that this bill also puts in motion a process whereby the interest rates on student loans would be halved over a four year period. If cost of capital rises while federally mandated interest rates decline, lender profits will be significantly squeezed. It is unlikely that lenders can make up for this kind of margin compression via origination fees, late fees, handling fees, etc. though they will certainly try.

In terms of grants, Congress is increasing Pell grants for low-income students. Students with grants will obviously need less in the way of loan money so this will impact loan volume. The Democrats claim they are replacing the funding, around $12 billion, that was reduced by Republicans in previous years so this may end up being a wash.

Another change that will reduce lender profitability is related to PLUS loans. These loans are part of the FFEL program and are made to parents to pay for the education of their children. Instead of rates being set in Washington, the government will now auction off the right to make federally-backed educational loans to parents in each state, instead of setting the rate from Washington. The two lowest bidders will win the right to make subsidized college loans to parents. This increases uncertainty about expected loan volumes and will tend to result in lower rates for borrowers (ie, lower margins for lenders).

Lenders will try to offset losses but...

Besides increasing fees, lenders have the option of tailoring their private loan products in ways to increase profitability. Private loans are increasingly important to both borrowers and lenders as the FFEL program has annual loan limits that are far below the cost of education for most schools. Look for lenders to set these loans to higher interest rates.

Impacts on Sallie Mae underestimated

Sallie Mae claims that the impacts of this bill will be limited to merely 2% or so of "core earnings" net income over five years. Given all the implications of the legislation as described above, 2% seems like a huge underestimation of the true negative impact. To reduce the impact to only 2%, I can only think that Sallie Mae intends to securitize large portions of their portfolio. That is like selling the furniture to get through a short-term rough patch. I agree with JC Flowers -- this deal should be renegotiated.

Disclosure: author owns no shares of Sallie Mae

Comments

Hi
Now we are bullish on Indian Stock/Share market to see on new highs. Now Sensex is due to kiss 18000 mark Till Diwali or beforeDiwali. So now starts count on us to see Sensex on 18000 Mark.

Now BEST Buy is INFOSYS for Trgt 2000-2100. RELCAPITAL for Trgt 1800, RNRL For Trgt 100-110 & APIL for trgt 1000


Regards.
Sai Stocks n Shares

Popular posts from this blog

Unlock Stock Market Profits - Key #1

This is the first in an ongoing series of articles where I discuss what I feel are keys to successful investing. It is based on a post that provides a summary of the ten keys that individual investors should use to identify profitable stock trades. ( Click here to read the original post ) There are two basic steps to investing. First, you need to find stocks that seem to have some potential. Then you have to determine whether these stocks are actually good investments. There are many stocks that at first glance look interesting, but further research reveals that there are too many negatives to warrant taking a position. This first post in the series starts at the beginning: getting good investment ideas. Key #1: If something special is happening to a stock, it will be reflected in some kind of unusual activity in the markets. As individual investors, we will never be the first to know; however, unusual activity can be an early sign that allows us to follow the Wall Street profess

Unlock Stock Market Profits - Key #4

This is the fourth article in a series of posts describing 10 tools to help you identify and evaluate good investing ideas. It is based on a post that provides a summary of the ten keys that individual investors should use to identify profitable stock trades. ( Click here to read the original post ) With this fourth post, we will continue another step along the path of finding stocks that seem to have some potential. The first post in the series discussed how to use unusual activity to identify investing ideas. The second post described how to use stock screeners. The third post described how to use lists of new highs and new lows. This post will focus on identifying social or business trends in order to find investing ideas. Information on new trends might turn up anywhere. In conversation with friends or business associates, in newspapers or magazines, on TV or though your work. The key is to be aware of trends and how they start, stop or change. We'll start by describing wh

Interactive Ads - Google one-ups Yahoo again

Google's ( GOOG ) press release describing the expansion of a beta program for what are being called Gadget Ads has again shown that Google is unparalleled at melding technology and advertising to benefit its bottom line. Gadget Ads are mini-web pages or "widgets" that can be embedded within publisher pages. I have written in the past on Yahoo's ( YHOO ) Smart Ads and how, by more precisely targeting site users and adjusting ad content accordingly, they provide a much desired evolution of the banner or display ad format. Though Smart Ads and Gadget Ads are not really the same, I think it is fair to say that Google has seen the challenge of Smart Ads and has chosen to leapfrog Yahoo by rolling out its own update to the display ad format. The evolution of the Gadget Ad -- One of the trends on the Internet over the last year or so involves software developers creating "widgets" which can be hosted within web pages and blogs. Widgets can be pretty much any