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Sallie Mae and Student Loans

Written By Brian Hicks

Posted June 3, 2013

Sallie Mae (NASDAQ: SLM) has decided to split itself in two publicly traded companies. One will handle federal student loans, while the other will focus on private loans. This should be seen as a clear indication that the private student loan market is growing significantly.

Back before 2008, private student loans could be had quite easily. They often came with steep rates, as Bloomberg notes. But over the past half-century or so, college costs have risen sharply across the nation.

unemployed studentThe causes are various, and include the mushrooming of questionable 2-year and “for-profit” online institutions, the infiltration of colleges by administrators demanding astronomical salaries, and an ever-growing obsession with collegiate athletics. This last cause has, especially over the past decade, often seen colleges and universities featuring athletic coaches who earn more than several top-tier faculty members combined.

Of course, all of this has reflected on the public and its ability to afford higher education. Thus it is that today, student loans total $1 trillion. That makes it the largest bracket of consumer debt after mortgages, and of that $1 trillion, 15 percent are private loans.

Presently, Congress has set itself the task of somehow solving what many analysts—both financial and in higher education—have identified as a bubble that’s growing unsustainably. The proposals in question would lead to reduced interest rates for federal loans and generally make them more attractive so as to stave off the encroachment of private lenders. However, with no immediate turnaround to the problem of escalating college costs in sight, investing with Sallie Mae is actually a wise choice.

Another factor why Sallie Mae has shifted focus to the private market is because of the Obama administration’s 2010 move, which handed control of private lending directly to the government. But Sallie Mae still services and collects on those loans. In addition, the company has $118 million in federal loans made prior to the government shift.

The Student Loan Crisis

Private loans are certainly not an attractive option for students. For one, payments can often not be deferred or pegged to income. For another, interest rates can exceed 10 percent per annum, and rates are usually variable (and therefore may result in abrupt rate increases in the future).

But Sallie Mae insists that it has tightened lending practices by increasing oversight of creditworthiness, thereby reducing the volume of loans but increasing the quality of those loans. That shrinkage is on a national basis; 2012 saw private student loans drop to a mere $8.1 billion, and that’s where Sallie Mae sees opportunity. In a conference call, the company claimed expectations of $4 billion in private loans over 2013.

One of the biggest challenges to private loans comes from certain Senators (like Dick Durbin, D-Ill.) who have demanded that these loans, like all others, be made dischargeable via bankruptcy. And Sallie Mae, wisely, has expressed support for this motion.

The White House is watching the situation keenly, too. July 1 will see Stafford rates jump from 3.8 percent to 6.4 percent unless Congress takes action. Along similar lines, President Obama has expressed interest in enlarging the Perkins loan program. Both of these will directly influence the fortune of private lending.

Sallie Mae itself has been doing fairly well; the company is up 36% year-to-date, currently trading at $23.85. The aforementioned company split will be accomplished via a tax-exempt distribution of common stock amongst shareholders. All should be completed within the next year.

Forbes notes that Sallie Mae will see loan originations rise to $4 billion by 2014 (from 2010’s $2.3 billion), while the company’s market share of private student lending is set to exceed 50 percent from 32 percent over the same time period.

College enrollment keeps increasing every year, and so do the costs. Needless to say, income and savings have not grown rapidly enough to match that. That means borrowing for college, at least in the short term, is bound to keep increasing.

At the same time, default rates on these loans are now at 13.4 percent, per the New York Times. With both lending amounts and default rates going up, the Consumer Financial Protection Bureau is justified in anticipating another sub-prime crisis—this time in the student loans market. 


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