What Is Sallie Mae And How Does It Work?

During the financial crisis of 2008, many companies, particularly financial companies ran into difficulty and required financial bailouts from the government.  The public were none too happy about all the money doled out to prop up some financial companies like AIG (AIG), but some other companies received funds with very little fanfare or public where-with-all.  One such company was SLM. 

What is Sallie Mae?

SLM Corporation (SLM), more commonly known as Sallie Mae, operates as a financial services company that focuses on educational loans in the United States. It also offers banking products and various types of insurance for students and young adults including auto, life, travel, health and renters.  At its beginnings in 1972, Sallie Mae operated as the Student Loan Marketing Association, a federally-chartered, government-sponsored enterprise.  Although that government status was terminated in 2004 and the company become incorporated, it was still viewed as a government agency by many outsiders.  Confounding this perception, starting in 2004 its “quasi-government” status persisted because it offered and serviced the Federal Family Education Loan Program (FFELP). FFELP loans were education loans offered by private companies that were guaranteed by the US government and Sallie Mae was the largest originator of these loans.  Sallie Mae and other banks would then resell these loans to investors to make additional revenue. 

During the financial crisis, the government was worried about students’ abilities to access these loans if the private companies that offered them were unable to resell the loan packages to the credit market, so the government stepped in.  The bailout was approved by the  Ensuring Continued Access to Student Loans Act (ECASLA), which allowed the Department of Education to create programs to buy the packaged student loans the credit market stopped buying during the financial crisis.  But that all ended with the Health Care and Education Reconciliation Act of 2010.

In 2010, the government ended the FFELP, deciding to become a direct lender to students through the Direct Loan Program.  As such, Sallie Mae cut its strong for-going ties with the federal government, transforming to just another private financial company traded on the public market.

How Sallie Mae Works

The loss of the government-backed student loan business prompted Sallie Mae to review its going concern operations which in May 2013 resulted in the company announcing it was separating its lines of business into two distinct entities, offering both to the public.  Sallie Mae derives the bulk of its revenues from both the education loan management business and the consumer banking business, and that’s how the two separate entities are positioned.  One entity handles portfolio management, servicing and collection of student loans, which accounted for about 95% of the total Sallie Mae assets, including the close to $120 billion in FFELP loans.  The second entity handles all the private loan origination and servicing businesses including Sallie Mae Bank and its private education loans and was named SLM Bank Co.  Although this second entity is starting out with a substantially smaller asset base (about 8% of total assets), it is expected to grow while the other company is expected to shrink in line with the shrinkage of the FFELP over the next 20 years. 

Is the Business Case Sound?

The fundamental case for education loans appears strong based on three factors:  the cost of a four-year college, which continues to go up mid to high-single digits per annum, far out-pacing the rise of the consumer price index, enrollment at four-year institutions, which is projected to increase by 12% from 2012 to 2021, according to the Department of Education, and the availability of student loans.  So basically if the “cost of education continues to increase at a pace exceeding family income and savings growth and the availability of federal fund grants, and scholarship levels remain constant or decrease, more students and families can be expected to borrow privately,” according to the company’s latest annual report.  

The Bottom Line

Sallie Mae, which started out as a marketer for government loans, will morph into two separate publicly traded companies, each with an eye toward transacting in the student loan business - one as a legacy servicer with a slowing stream of revenue and the other as a growing private lender.  This company, while in transition, has a good opportunity in its market segment. The latter's growth from both the population as well as the cost sides has no signs of abating.   

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