Where there's noise from Washington, risk happens, often creating an investment overreaction, then an opportunity.
In this regard, recent campaign-related headlines may be creating another interesting chapter in the saga of Sallie Mae (SLM), the former student loan GSE that was attacked, then allowed to privatize during the Clinton administration. That story initially created such excessive disdain for Sallie that a reversal (as worst-case fears were avoided amid a company restructuring and favorable political realignment) ultimately reaped 16-bagger rewards for shareholders between Election Day 1994 and Election Day 2006.
Along with far less risk than at the start of that amazing run, any relief rally for Sallie stakeholders today would be far less pronounced. For holders of much-maligned large banks, the issue, if not space, is now virtually meaningless, as witnessed by recent lending pullbacks by USB and JPM. Meanwhile, as a political analyst I don't make investment recommendations anyway. But I am good at smelling the build-up of likely-exaggerated policy risk concerns. And once the student loan industry has been dragged through the ringer over the election-year Washington summer, odds are pretty good that not much will have changed.
So What Up?
Thanks to President Obama, the rate on federal student loans has recently been made a political football. On swing-state college campuses, he has called on Congress to pass legislation heading off for at least a year an otherwise scheduled doubling of rates on new direct loans, from 3.4% to 6.8%, effective July 1. He even devoted his April 21 weekly address to the cause, and highlighted it while "slow jamming the news" with late-night comedian Jimmy Fallon.
This, in a vacuum, doesn't present a threat to anybody (except Mitt Romney, if it helps Obama to once again energize 18-29 year-olds). Sallie and its mini-me competitor Nelnet (NNI) would be unaffected by any rate change or continuation of the status quo, given prospective impact only upon new loans and the fact that originations under the federally subsidized student loan program ended at Obama's and the Democrats' bidding in summer 2010. As a result, it would not impact the runoff income SLM is enjoying from its giant legacy portfolio of guaranteed loans, which have a typical life span of ten years or more.
Nevertheless, the bill as it goes to the Senate floor threatens not only to generate hostile rhetoric toward the industry -- which could be compounded if a Consumer Financial Protection Bureau (CFPB) study arrives in time to further soften the political battlefield -- but it also could take on added amendments, most notably in the form of provisions that might restore the dischargeability of private (non-federal) student loans in bankruptcy.
The 2010 repeal of the private-lender-dominated Federal Family Education Loan Program (FFELP) sharply reduced political risk for lenders still helping to finance students through college. Nevertheless, Sallie doth still bestride the narrow world of private loans like a Colossus. And Washington could yet make things difficult for purveyors of such alternative loans.
There seem to be two potential threats in the context of likely passage of the student loan bill preserving the current low rate sometime later this spring. As mentioned above, Congress could attach reforms allowing bankruptcy judges to order discharge of outstanding private student loan debts. Or Sen. Sherrod Brown's (D-OH) Debt Swap bill to allow refinancing of private loans into federal Direct loans might also be added to help offset the measure's $6 billion annual cost.
Only the first of these seems a halfway legitimate threat (even Senate liberals are wary of the precedent of consolidating private loans into federal ones, as under the Brown bill). Meanwhile, bankruptcy reform might do little to harm what many see as a positive Sallie investment equation.
Specifically, even if dischargeability of loans were to be restored (repealing language inserted in the Bush-era Bankruptcy Reform Act, which Republicans will likely close ranks to reject), Sallie confirms that its book of private loans originated over the past five years has been "heavily cosigned and underwritten to high FICO scores. For co-signed loans to be expunged, parents or relatives would also have to be filing for protection. Meanwhile, residual loans before 2007 might be a bit more at risk.
But should we see emergence of a legitimate threat that such language might become attached to a final bill, industry lobbyists hope to persuade Congress to make a rational and mitigating tweak. A borrower shouldn't be allowed to walk away almost as soon as he or she has graduated (with a life-time asset worth $650,000 to $1 million locked in), they argue, but rather only after the loan has been repaid for four to five years. Such a change, should Dems accept it, would greatly and more fairly insulate the lender's portfolio.
In any event, while I'd put 90% odds on rate-preserving legislation's passage (after a noisy partisan faceoff over how to offset the $6 billion price tag), I'd strongly doubt that bankruptcy reform becomes attached. Perhaps helping on this score are reports that the White House is pressuring Senate Dems to pass a "clean" bill. And if by luck the legislation is wrapped up by early June, the landing of the CFPB's likely-damning report a month later could prove far less consequential. Longer term, some would even argue that the CFPB's student loan ombudsman could ultimately prove a positive for the industry, providing a central contact for complaints, helping to remove bad actors and standardizing, if not insulating, such assets from future lawsuits.
Having lost 10% of its value since early spring (while NNI and the SPX have stayed essentially flat), amid concerns over the upcoming Washington kerfuffle over student loans, Sallie stakeholders might once again enjoy relief as the tension fades in late summer.