Shares of Sallie Mae (SLM) have lost 14% over the past four sessions for policy-risk reasons that seem grossly exaggerated. As a result, the splendid company-split story that Sham Gad and I wrote about ast October is now on sale.
What happened, and why might it prove a buying opportunity? First, SLM fell just under 10% last Friday as the company, on its earnings call, was forced to cite lost "loan rehabilitation" revenue due to December's Murray-Ryan budget deal. That agreement sewed relief from the typical fiscal folly concerns that investors have had to deal with each of the past three years. But it's associated budget savings came partially at the price of cuts to subsidies awarded to student loan guarantors. Sallie Mae was exposed to those cuts as a result of having crafted a 2000 services contract with one of the largest guarantors, in essence making Sallie Mae the operator of USA Funds.
While Sallie acknowledged that the loss of future loan rehab subsidies could cut $120 million or more from its revenues, a point to note is that guaranty agency operating funds have been structured on the assumption of new fees, from new originations, coming in. So, with the repeal of the former private-lender-dominated FFELP program back in 2010, the guarantor model has already been seen at high risk and the latest subsidy cuts might only hasten that verdict. Nevertheless, with SLM holding a market share of less than 10%, a bigger question might be who might stay in and who'll stay out, with potential for Sallie gains to at least partially offset the direct subsidy losses.
Yesterday's 5% follow-on drop in SLM seemed even more questionable, with many investors pointing to a top investment firm's report about the possibly negative effects from legislation to be introduced soon by Sen. Elizabeth Warren (D-Mass). I haven't read the report, but most critics lambasted it for an exaggerated analysis of the impact from the Senator's plan to allow for the refinancing into Federal Direct loans of some $400 billion plus in legacy FFELP assets originated by Sallie and other private lenders before the program was repealed in 2010.
I'd note that we haven't even seen the details of Warren's plan, which could be important, since borrower buy-in was as low as 5% when a similar opportunity was created by the Obama administration in 2012. Since you can only lead an indebted student to water, but can't make 'em drink, how do you model that? Meanwhile, it's not even certain yet whether only outstanding FFELP loans will be affected, or outstanding direct federal loans and non-federal private loans might be as well. As a guide, the broader the measure, the less digestible (and passable) it will be.
More importantly, the emerging bill seems designed as much, if not more, for the delight of student groups and other left-leaning Democratic constituencies (and Warren's would-be presidential aspirations) than it might be for serious advancement of legislation. Indeed, a blog from the New America Foundation, and a National Consumer Law Center (NCLS) report attacking Sallie Mae, specifically, have front-run Warren's bill, trying to salt the political ground with accusations that private lenders continue to earn undue profits and that Sallie, as the industry's biggest, could be a poster child for why student borrowers and their families might be suffering as a result.
These arguments will stir up the left, but are old hat in Washington and hardly worthy of a thaw in the long-established Hill dialectic over FFELP vs. direct loan subsidies. Obama and the Democrats only won on this the last time when they controlled both chambers of Congress and were willing to go to controversial procedural maneuvering to also pass the Affordable Care Act (to which the 2010 FFELP program repeal became attached with no GOP votes).
Bottom line, more headline risk is ahead as Warren, the liberal avatar, lays down her proposal and her acolytes sing its praises. But I wouldn't put more than 10% odds on it gaining traction. As I mentioned, its assumed budget savings (which some say could total $16 billion) will be quite controversial and hardly acceptable to Republicans, particularly if the GOP retakes the Senate in November (a 40% prospect).
Associated expansion of the federal balance sheet would also add tens if not hundreds of billions to the outstanding national debt, just as another struggle over the debt ceiling comes to a head.
The proposal would largely help middle-class borrowers who are current on their loans, hardly seen as being under duress (making resistance less risky politically).
Finally, House and Senate Republicans, and even pro-industry Democrats, will no doubt contend that the issue would be best addressed within the context of Higher Education Act (HEA) reauthorization. That effort may start this spring, but will unlikely take shape meaningfully until 2015 or beyond.
In other words, there are two speeds in Washington: now and not now. While President Obama, during his State of the Union address next Tuesday might confuse the situation by doffing his cap to the merits of providing "more opportunities for students to refinance their college loans," he'll be talking about the CFPB's efforts to cajole the industry into voluntarily providing new options to holders of higher-cost private loans, rather than endorsing Warren's proposal. So the time for the Warren bill -- just like many of her lethal plans for TBTF banks -- is not now, if not never.
Meanwhile, if I'm wrong, I'll have been more wrong in my enthusiasm for the Sallie split than Gad. And that's because I've expected the NewCo subsidy created to manage legacy student loans to grow by aggressively purchasing legacy FFELP loans from other players seeking to get out. If those loans are instead being aggressively converted into direct loans, along with much of Sallie's $130 billion plus portfolio, well, it's a different story.
One consolation prize worth mentioning, as well, compliments of a savy hedge fund manager. To the extent FFELP loans might be called away, Sallie would free up excess capital, which it could use to buy back additional shares.
