Sallie Mae Reports 3Q "Core" Earnings of $0.19, down 68% from 3Q of 2007

As indicated in the headline above, Sallie Mae recorded "core" earnings dropped 68% on a year over year basis.  There are five key questions that I am hoping to answer after skimming their 62 page Supplemental Earnings Disclosure for 3Q 2008 (some questions may have to wait for the conference call tomorrow which I hope to be live blogging at 5 AM Pacific Time tomorrow!):

1.  What has been their growth in loan originations for FFEL and Private Loan products?  With students entering school in August and September, 3Q tends to be a peak lending season and provides insights as to how much share Sallie Mae may be picking up given the turbulence in the student loan market.

Answer:  Page 43 of the supplement provides data on FFELP and Private Loan originations for Internal brands and lender partners.  Here is a summary table:

	In Millions of Dollars
	9/30/2008	9/30/2007	Change
FFELP
Internal Brands	$     4,823	$     3,201	50.7%
Lender Partners	$       711	$     2,858	-75.1%
TOTAL	$     5,534	$     6,059	-8.7%
Private Loans
Internal Brands	$     1,934	$     2,560	-24.5%
Lender Partners	$       183	$       233	-21.5%
TOTAL	$     2,117	$     2,793	-24.2%

Here is Sallie Mae's explanation on the origination trends:

• FFELP originations:  "As a result of the impacts described above, our FFELP internal brand originations in the quarter were up sharply, increasing 51 percent from the year-ago quarter to $4.8 billion. Our FFELP lender partner originations declined 75 percent from the year-ago quarter. A number of these lender partners, including some of our largest originators representing approximately 50 percent of the decline in lender partner originations from the
  year-ago quarter, have converted to third-party servicing arrangements in which we service loans on behalf of these parties."

• Private loan originations:  "Consistent with our announcement in the first quarter that we were tightening our private credit lending standards and ceasing non-traditional lending, Private Education Loan originations declined 24 percent from the year-ago quarter to $2.1 billion in the current quarter.

2.  What have trends with delinquencies been with the private loan portfolio?  Sallie Mae took a significant allowance for private loan losses in January of 2008 for their non-traditional loan portfolio.  Investors are interested in understanding the adequacy of those reserves given the recessionary economy we find ourselves?

Answer:  Page 38 provides an excellent chart of the delinquency trends for the traditional (85% of the loan portfolio currently in repayment) and non-traditional (15% of portfolio) private loan portfolio for Sallie Mae.  Sallie Mae has broken out these portfolios since the fourth quarter of 2007 given the rising delinquencies and chargeoffs in the non-traditional portfolio.  Here are the highlights of the table on page 38: 

• Overall, delinquencies in the private loan portfolio have increased to 9.4% as of September 30, 2008 as compared to 7.7% last quarter and 8.5% during the third quarter last year.  
  • This was primarily driven by the traditional loan portfolio, which had delinquencies rise to 6.3% as of Sept. 30, 2008 from 4.9% last quarter and  5.4% in the same quarter a year ago.
  • The non-traditional portfolio also saw an increase to 26.3% in the latest quarter, up from 24.0% in the last quarter and 25.2% in the same quarter a year ago. 

• The percentage of loans in forbearance declined to 11.5% from 13.0% last quarter and 13.2% a year ago.   Forbearances, as defined in the supplement are "loans for borrowers who have requested extension of grace period generally during employment transition or who have temporarily ceased making full payments due to hardship or other factors, consistent with the established loan program servicing policies and procedures."  
  • The company provided the following explanation for the drop: "We recently implemented a risk-based eligibility model to assess the potential effectiveness and benefit of forbearance for individual borrowers. This process was implemented to mitigate the overall risk of the portfolio as well as to encourage cash resolution of delinquent loans. These changes have reduced the percentage of loans in forbearance as noted above.
  • Company also provided data to show their default experience with loans in forbearance:  "As reflected in the table below, our experience has consistently shown that three
    years after being in forbearance status for the first time, over 75 percent of the loans are current, paid in full, or receiving an in-school grace or deferment, and approximately eight percent have charged off."

• Reflecting worsening expectations regarding their private loan portfolio, the company slightly increased their allowance for loan losses to $1.35 billion in the third quarter from $1.29 billion in the previous quarter.  
  • Here is the explanation:  "The increase in provisions for loan losses relates primarily to increases in delinquencies on both FFELP loans and Private Education Loans (see “LENDING BUSINESS SEGMENT—Private Education Loan Losses— Private Education Loan Delinquencies and Forbearance” and “— Allowance for Private Education Loan Losses”) primarily as a result of the continued weakening of the U.S. economy."

3.  What are the pricing trends for private loans?  A recent analyst report indicated that loans were currently being priced at LIBOR + 9.8%.  Should that be the expectation going forward or what are they forecasting over the short or mid-term time horizon?

Answer:  No information provided in the supplement.  This is a question that analysts like to ask about so I expect to hear more about this tomorrow. 

4.  What are the prospects for Sallie Mae to raise capital through securitizations of FFEL or Private Loans?  An analyst had recently indicated that SLM was marketing a Private loan securitization.  What reception are they seeing in the marketplace for these securities?

Answer:

• Regarding the securitization markets, the company provided the following assessment:
  • "Since late September 2008, the severe dislocation in the financial markets has made FFELP and Private Education Loan term ABS funding generally unavailable. At present, we are unable to predict when market conditions will allow for future issuance of term ABS. The Company’s last FFELP term ABS issue was completed on August 28, 2008. The Company’s last Private Education Loan term ABS issue was completed in the first quarter of 2007. We expect to resume term ABS issuance as soon as market conditions permit.

• For an assessment of the trends in FFELP securitizations over the past three years, the company indicated:
  
  • "We securitized $25.4 billion of student loans in nine transactions in 2007,
    compared to $32.1 billion in thirteen transactions in 2006. More recently, adverse conditions in the securitization markets have reduced our access to and increased the cost of borrowing in the market for student loan asset-backed securities. We completed three FFELP term ABS transactions totaling $6.7 billion and nine FFELP term ABS transactions totaling $18.5 billion, in the three and nine months ended September 30, 2008, respectively."
    • All-in costs remain high:  "All-in costs of our new issue FFELP term ABS averaged
      LIBOR plus 1.44 percent in the third quarter of 2008. The Company’s most recent FFELP term ABS issue was priced on August 21, 2008 at a weighted average cost of LIBOR plus 1.67 percent."

5.  What will the impact be of their recent decision to raise their underwriting standards for private loans?  Did they make this decision based on rising delinquency trends or limited capital available?  If limited capital, what are their plans to ameliorate the situation and are they in discussions with government about ways to inject capital into the student loan marketplace?

Answer: 

• The company did cite the following issue that has arisen as a result of the dislocation in the credit markets which has fundamentally changed the historical relationship between the 3 month commercial paper market and the LIBOR market:
  • "As of September 30, 2008, on a Managed Basis, we have approximately $120 billion of FFELP loans indexed to three-month commercial paper (“3M CP”) that are funded with debt indexed to LIBOR. We believe there is broad market recognition that, due to the unintended consequences of government action in other areas of the capital markets and virtually no issuances of qualifying commercial paper, the 3M CP index and its relationship to LIBOR is broken. We are working with government officials to swiftly address this issue.

• No information provided in the supplemental information about their recent decision to increase their underwriting standards for their private loan program.  They did provide a table which showed a decrease in the total sources of primary and stand-by liquidity for general corporate purposes (which primarily includes originating Private Education Loans and repaying unsecured debt as it matures) to $21.2 billion from $45.5 billion a year ago.