Cashing in on Student Loans

Student loans are a huge and surprisingly profitable business. Just ask the folks at the Student Loan Marketing Association nick named "Sallie Mae," which owns the debt of about one third of all educated people paying back college loans.

Chartered by the federal government in 1973 but operated as a private firm. Sallie Mae encourages banks and universities to make student loans by guaranteeing their security. Its most common tactic includes purchasing loans originally made to students from the banks themselves under the assumption that banks will lend more easily if a safety net exists to buffer the very risky and unprofitable market.

Sallie Mae appears like a very altruistic fall guy for a good cause assuring that college students can get money for school. But with very conservative management practices and a corps of young highly aggressive officers. Sallie Mae last year made $66 million in profits while managing $6.7 billion worth of student debt, a 79 percent jump over 1982 itself a remarkable year with profits skyrocketing 109 percent over 1981 levels. But these profit motives have driven up the cost of student loans officials admit dampening the original goals of the agency.

What the Washington, D.C. based company does is hardly remarkable in itself. Sallie Mae is a "secondary market" for student loans a bank for banks that lend to students. Like any other bank it makes profits by charging borrowers more than what it costs to lend to them all with the government's blessing.

Success

The company now publicly owned was started in conjunction with most of the nation's prominent universities. Sallie Mae's fabulous financial success transformed an initial $400,000 investment by Harvard in 1974 into a whopping $14 million by the end of 1983. Other colleges have reaped similar if not as spectacular sums.

Harvard currently ranks as the fifth largest stockholder of the company behind Citibank Chase Manhattan, the First National Bank of Chicago and Brown University.

The union of profits and public service makes Sallie Mae "a very interesting success story and one Harvard can be very proud of ," says College Treasurer George Putnam '49, one of the company's founders.

Mechanics

Sallie Mae also runs a "warehousing advance program," under which financial or educational institutions looking for cash advances to maintain or increase their student loan programs pledge their loan portfolios or government securities to Sallie Mae as collateral.

Also its "commitment program" has proved very useful to colleges participating in government sponsored loan programs because they can sell bad loans to Sallie Mae and avoid getting burned by delinquent alumni.

Family

Sallie Mae is just one of several government created private organizations with women's names all designed to serve a public purpose while making money at the same time. Three of the most important Fannic Mae (Federal National Mortgage Association). Ginnie Mac (Government National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) all serve as reservoirs for home mortgage loans.

While Sallie Mae has grown to be the predominant secondary market for student loans many higher education sources say the company has become preoccupied with turning profits. David Longenecher of the Minnesota Higher Education Coordinating Board a $100 million "last resort lender" to students who can't get loans anywhere else says. "We're kind of critical of the way in which (Sallie Mae) has done business which is on a very profit oriented basis. Its profit motive seem to have taken precedence over its public purpose."

Better Deal

Longenecher says that in Minnesota and other states local banks are much less reluctant to take loans than Sallie Mae.

"We found that we could get a better deal from banks here in the Twin Cities area and they will provide us with better secondary market activities. We found we could get a better deal from the banks than from Sallie Mae and the reason for this and this is kind of perverse is that their profit requirements were fairly lower than Sallie Mae's."

He adds that Sallie Mae has been "tremendously risk averse in a business that is built on risk. They were quite willing to purchase the high balance loans, on which they made a lot of money but they were very uninterested in being involved in any of the low balance loans, which were unlikely to make any profit for them and the ones which were most likely to go into default."

The students hurt most by Sallie Mae's reluctance to buy the small loans are those in small loans are those in small colleges and vocational schools, where tuition and thus the size and profitability of small loans are relatively lower. Banks are unwilling to make these loans both because of the low profit margin and because Sallie Mae will be reluctant to buy it or will only pay less than face value for the debt.

"I don't think it would be fair for you to criticize that as a discrimination on their part but just a characteristic of the loans they participate in," says David B. Laird of Springston, Inc... a St. Paul firm that advises several state loan authorities, "Sallie Mae has historically said to the small banker. "We'll take your high balance loans where the student is still in school, but for all the rest of them we're going to give you a discounted price."

Strange Beast

But Longenescher says he blames part of Sallie Mae's reluctance to buy the small loan on the way Congress set up the company. "They structured a strange beast there one that has got a profit motive while serving a public purpose. When you create a profit seeking organization it would be unrealistic tie not to expect it to make a profit. I think that if they had created a non profit organization with the same goals it might have been different. I don't blame Sallie Mae I just don't like it."

Edward A Fox, Sallie Mae's president since the company was formed agrees that the firm was very risk averse during its early years, but with good reason. "When we first started out in 1973, we had no capital no net worth no funds to speak of. We were sort of held together by wax and tobacco juice," Fox says.

When Sallie Mae tried to hold a stock offering in 1973 and got no takers the 46 years old Fox says "the board reached an absolute consensus that in order for this corporation to attract capital, which is important for its social mission we had to have a balance sheet that could encourage investors to want to participate in the corporation. If we couldn't attract capital all the social goals that we had could not be satisfied."

Sallie Mae tried in 1974 to sell a $25 million stock issue and found buyers including Harvard in the educational and financial communities.

Putnam says he was very active in this stage of getting Sallie Mae off the ground personally persuading Harvard and other universities to buy stock in the early days. "I was just acting as a public citizen," Putnam recalls adding, "I said it's is a good thing. Let's make it go."

Putnam convinced Yale, Princeton, MIT, Notre Dame, Stanford, Wellesley (where he served as chairman of the college's finance committee), and other colleges to invest in the fledgling company at costs ranging from a minimum $5000 to $400,000 the size of Harvard's initial stake. Those who bought the most did the best.

Persuasive

With the help of Assistant Treasurer George Siguler (now on leave as chief of staff of the Department of Health and Human Services), Putnam had little trouble selling others on the concept. "If Harvard thinks it's a good investment as well as a good thing to do that was a very persuasive thing," he says. "I just gave them the sales pitch and that's all they wanted to know."

Thus the fledgling Sallie Mae moved into 1974 with $25 million of capital backing on the $1 billion worth of student loans that it already had purchased. Then as now most of the loans Sallie Mae owns were Guranteed Student Loans made by the Department of Education to college students. Depending on when students took out the loan they pay 7,8 or 9 percent interest after they get out of college and the government pays the interest while the student is in school.

"Over the first five years we grew to be a $500 million corporation, which is relatively small. During that time we were profitable, but by no means really profitable," Fox explains. While Sallie Mae busily built a fairly sophisticated marketing network and financial system, the company also was operating under fairly rigid conservative banking practice.

Burgeoning

During the late 1970s and into the 80s the demand for student loans exploded largely because of the rising cost of higher education and a 1978 government decision onto make GSLs available to any student on very generous terms.

Sallie Mae was already positioned for this new demand for student credit and in the five years from 1977 to 1982 blossomed from being a $500 million company to a $5 billion one an incredible growth for any business.

But the balance sheet had become debt heavy Fox says that by 1983, Sallie Mae's capital base had grown to about $100 million while the debt of the corporation was nearing $7.5 billion. "We had a corporation that had 75 units of debt for each unit of capital, which is about four times what most commercial banks have," Fox says.

Needing a drastic increase in funds to back the huge debt, Sallie Mae went public in September 1983, with a 6 million share stock offering Demand for out stripped that 6 million level, so the sale was increased first to 8 million and finally to 10 million shares.

Concurrent with the public offering of non voting shares, Sallie Mae went into a 35 for stock split of its voting shares those which were bought in 1974 by universities and banks Institutions with voting shares got to convert about one third of their new post split shares into non voting shares and sell them and altogether an additional 1.5 million shares entered the market. So what was planned as an offer of 6 million shares at $17 a share ended up as a sale of 11.5 million shares at $20 a share.

Harvard however did not convert any of its 840,000 shares into non voting stock to sell much to officials later regret. The voting stock because of its qualifications on ownership voting shareholders have to be participants in the Guaranteed Student Loan Program has traditionally been worth less than non voting shares.

Poor Foresight

"We never expected the split between voting and non voting shares," says Harvard Financial Vice President Thomas O Brien one of 21 board members of Sallie Mae Voting stock traded at $16 at the time of the public offering while non voting started at $22 and later jumped to $28 a share. "If we knew what the split in values was going to be we definitely would have sold," he adds.

But O'Brien says that Harvard will certainly convert and sell as much of its voting stocks as it can when the conversion will next be permitted this summer. "Looking at the spread you have to sell," he explains.

Sallie Mae's success says Longenecher has fostered a highly competitive environment for student loans. "There are very few pockets of unmet need for secondary markets today and so you will find Sallie Mae marketing more aggressively. I'd say that now, we almost have the opposite problem almost too competitive and environment. A lot of people are trying to make the faster profits that Sallie Mae did."

Fox says that Sallie Mae recently received an 'AAA' rating for credit worthiness making it one of only three financial institutions in the country with the highest possible rating. This means the company can borrow at lower interest rates and increase its profits handsomely.

Future

Sallie Mae's future depends largely on federal legislation, Fox adds. The OPTIONS program formed in 1980 allowed students with several different loans to consolidate those debts and sell the sum to Sallie Mae a program that became very popular with Harvard graduate students. Sallie Mae bought about $400 million worth of these loans before the program was out in 1982, but Fox says that many congressmen are interested in bringing the OPTIONS program back which would revive an important market for Sallie Mae.

Moreover, Fox says that higher education is almost a $100 billion industry nation wide and that current trends will make it bigger demanding better financing.

"Because of the interest in increasing faculty salaries and attracting better teachers the cost of going to school is actually going up. And in the institutions of today we see very much a replay of what happened 25 years ago you know. "The Russians are coming the Russians are coming. Suddenly everyone wants to make a political issue out of better education," Fox explains.