Highlights Of Sallie Mae's 3Q Earnings Announcement

HIghlights from Sallie Mae's earnings announcement earlier this week (sources for this summary include 3Q earnings supplement and conference call transcript from Seeking Alpha):

• Company completed their strategic review which included evaluating whether or not to sell the FFELP portfolio (while retaining the servicing rights)...and the company chose to (drumroll, please)....keep the FFELP portfolio:  "So maybe there's another way of just saying that you are not going to see any dramatic balance sheet actions from the company at least anytime soon."  It seems that as long as they serviced the assets, they would need to keep them on their balance sheet.  

• Wondering how profitable it is to service FFELP loans?  Answer:  Very profitable, as in 90% cash flow margins.  "Our securitized FFELP portfolio generated $444 million in excess cash to the company in the third quarter and to put that into some perspective, our FFELP servicing costs in the quarter were $52 million." 

• Blamed increased federal aid for 6% decline in private loan originations: "Total Private Education Loan originations declined 6 percent from the year-ago quarter to $835 million in the quarter ended September 30, 2010. This decline was a result of a variety of factors, including an overall increase in the use of federal financial aid."
  • Here is commentary from the conference call which provides additional color on what the company sees in the marketplace:  "Our volume was about flat for the year ago. I'd like to think that it's bottomed out. Certainly it's an important question for us whether it's bottomed out but I can honestly tell you we don't really know that it has. Families remain very cautious, there is still a lot of federal money in the system, but we did notice that tuition and fees have begun growing again after a couple of flat years."
  • Federal loans and grants grew 30% (or an incremental $32 billion) in FY 2009 according to FSA's Strategic Plan for FY 2011-2015 (see chart on first page)
  • In terms of the quality of loans originated in the quarter, co-borrower rates jumped from 85% in the 2Q to 92% in the 3Q with FICO scores remaining constant:  "Loans underwritten in the quarter we are of very high quality, they had an average FICO score of 740 and 92% of the loans we made had a co-borrower. As a reminder loans with a co-borrower defaulted less than half the rate of loans without."
  • For further SLA analysis of private loan market trends in the 3Q, see this earlier post

• Indicated 17-18% of private loan originations came from the for-profit sector in the 2Q; lower percentage in the 3Q (first time I had heard these numbers from the company):  "There is something less than 17-18% I think...For this quarter was even lower. I think that was the second quarter number...We are focused on the full year and graduate degree lending segments and we don't see the pressure points quite as large in that area as you see in some of the other areas." 

• In terms of financing private student loans, the asset-backed security markets remain challenging:  "Although we have demonstrated our access to the ABS market in 2009 and the first nine months of 2010 and we expect ABS financing to remain a primary source of funding over the long term, we also expect our transaction volumes to be more limited and pricing less favorable than prior to the credit market dislocation that began in the summer of 2007, with significantly reduced opportunities to place subordinated tranches of ABS with investors." 

• Regarding collections of defaulted private loans the company assumes they will recover roughly 30% on these loans.  Based on their recoveries from their most recent two quarters, their estimated time to recover that percentage of defaulted loans is 8-9 years.  The company clearly wants to bring this figure down as they noted one reason for the increase in their operating spend in the 3Q was "higher collection costs from a higher number of loans in repayment and delinquent status..."

• Provided additional details about deal to acquire Student Loan Corporation's FFELP assets (including the source of funding):  "In the aggregate, approximately $28 billion in FFELP loans are involved. The aggregate purchase price is expected to be approximately $1.1 billion and will be payable in cash at the closing of the transaction. The Company anticipates the closing to occur in the fourth quarter of 2010 subject to receipt of necessary approvals.  The transaction will be funded by a 5-year term loan provided by Citibank in an amount equal to the purchase price."
  • Regarding additional consolidation of FFELP portfolios, the company noted that the pace had slowed:  "On the loan portfolio side of the equation, I think our biggest challenge to acquiring more portfolios is what the folks do with the proceeds. There is a real absence of opportunity for them and I think that has slowed down some of the potential loan sales that we would otherwise see. That said we still expect them to come most of the institutions that are holding FFELP portfolios that we expect to sell. It's a very small portion of their book of business and a run off-book just becomes more of an operational distraction and so we do expect them to sell.  That said The Student Loan Corp. deal was by far the largest transaction available out there by multiples."

• Indicated volume of loans currently being serviced under the DL contract, after their $20.4 billion sale to the Dept.:  "servicing approximately 3.3 million accounts ($42 billion of
  loans) under the ED Servicing Contract after the sale of these loans."
  • Sallie Mae can expect to receive about 1.3 million new accounts (or 22% of all accounts) for the second year allocation based on the Dept.'s Allocation Metric Calculation.  Sallie Mae scored highly  on borrower surveys but scored comparatively worse on the two default measures which explains why their allocation was below both Great Lakes and AES/PHEAA.  
  • The company was making about $5/account for the 2nd and 3rd quarters under this contract when they were servicing 2.0 million accounts.  The revenue ramps up as these loans enter repayment (see this post for details on the pricing model for the contract). 
  • Comment from company on conference call:  "On the Department of Education contract we were clearly disappointed with the score. There were components where we did very well. We received a top ranking for the service we provided to borrowers, albeit one of the more important metrics that we measure ourselves against. Unfortunately where we didn’t stack up, where we fully expect to be is on the default side of the equation and I would describe that. I hate to be complaining about technical issues, but it was a technical issue. We actually had loans that could default and others got their portfolios later in the cycle and so therefore defaults didn't have time to materialize, but the department did not adjust for those factors."

• Delinquencies for private loans improved across the board both sequentially and on year-over-year basis although write-offs remained stubbornly high:
  • Percentage of loans that were current stood at 88.9% for 3Q 2010 vs. 87.4% for the same quarter last year
  • Overall, delinquencies fell to 11.1% of loans in repayment compared to 12.6% for the same quarter last year
  • On the subject of charge-offs, the company noted the importance of a borrower making those first 12 payments:  "For example, approximately 80% of our charge-offs occur before a borrower makes 12 payments."
  • Sallie Mae's usage of forbearance also continued its downward progression to 4.3% in the 3Q from 5.8% last year.
  • Write-offs for the quarter stood at $348 million, up from $336 million last quarter and $443 million a year ago, which I believe was their peak quarter for charge-offs.  
    • Through first nine months, company has written off $1.0 billion of loans vs. $1.1 billion last year
  • The company also continues the practice of taking delinquent loans and providing them with a less than 30-day stint in forbearance and then converting them into current loans again.  Here is the company's explanation:  "As of September 30,
    2010, 3.1 percent [editor's note:  over $700 million] of loans in current status were delinquent as of the end of the prior month, but were granted a forbearance that made them current as of September 30, 2010."  This compares to 3.0% of loans in current status a year ago. 
• Will cut workforce by 2,500 jobs by the end of 2011:  "The majority of these restructuring expenses incurred through September 30, 2010 and expected to be incurred in future periods are severance costs related to the planned elimination of approximately 2,500 positions, or approximately 30 percent of the workforce."

Related articles:

• Sallie Mae keeps student loan portfolio (Wall Street Journal):  "SLM Corp. will keep its portfolio of federal student loans on its own books as it seeks cash to repay upcoming debt maturities and find other ways to unlock value for shareholders..."
• Sallie Mae '10 profit view above Street estimates (Reuters):  "However, the company -- which has been contemplating strategic options, including spinoffs and selling the remaining financial interest in the FFELP portfolio -- said it will not make a hasty move to realize "pent-up value" on its balance sheet."
• Sallie Mae moves to loss in 3Q on write-offs (BusinessWeek):  "Sallie Mae, formally known as SLM Corp., has been restructuring as it gets out of the federal student loan business. A law this year consolidated the federal loan program to save costs, and cut private lenders out of the process."