Like a lot of other companies in the battered financial services industry, the student lenders are now forced to deal with the new reality in credit markets, where the so-called "repricing of risk" has resulted in significantly higher rates, and therefore higher costs for the funding they rely on.
The last couple of months haven't been kind to SLM Corporation (NYSE:SLM) more affectionaly known as Sallie Mae. The first symptoms of credit crunch were felt in large moneycenter banks like Citigroup and Bank of America, but now it has spread to infect Sallie and the other pure players in the federally guaranteed student loan game like First Marblehead (NYSE:FMD) and Student Loan Corp. (NYSE:STU). (For related reading, see The Fuel That Fed The Subprime Meltdown and Taking Advantage Of Corporate Decline.)
Student Lenders Caught In A Vice
This unexpected cost squeeze comes at a time when the industry is still trying to recover from the hit it took last September, when reports surfaced that the U.S. Congress pushed through legislation slashing government subsidies paid to private student loan providers like Sallie Mae. The legislation followed a much-publicized scandal that exposed widespread kickback practices and conflicts of interest in the industry.
Two of the most negative provisions passed were the doubling of the origination fee that has to be paid to the government, from 0.5% to 1%, and the reduction of the federal government's default insurance coverage to 95% from 97% starting in 2012. The insurance reduction is viewed by analysts as damaging to the student loan debt securitization market. This is the market where Sallie Mae and other lenders buy and sell student loans to other investors. It's a key aspect of their business models.
Still Too Early To Be A Buyer
Battered by these negative developments, it's no surprise that shares of Sallie Mae and First Marblehead are now trading at 52-week lows. While this fact alone might tempt some contrarians to be buyers at this juncture, the prospect of a another body blow to the industry looms on the horizon that ought to give prospective buyers pause to reconsider. (To learn more, see Market Reversals And How To Spot Them.)
While the recent Congressional legislation did much to clip the wings, and profits, of the student loan industry, the scandal that inspired it still threatens to cause more pain. Right now, all three Democratic front runners, Hillary Clinton, Barack Obama and John Edwards, have committed themselves to ending, outright, the entire federally guaranteed student loan program. As these federal guarantees underpin the entire student lending network, this would have the effect of undermining their entire business raison d'etre. The replacement would be a range of higher education reforms that would be funded by the money saved from eliminating the federally guaranteed program.
The Bottom Line
The entire student loan industry, and its shareholders, have had to pay a high price for getting caught with their hands in the cookie jar. Judging by the polls, they may be facing a second, and even more painful, price to pay if the Democrats gain the White House next year. In the meantime, the credit crunch continues to grind on, squeezing the already narrow spreads the industry now has to contend with.
These stocks may be a lot cheaper now than they were even a few months ago, but I suspect they've got quite a bit further to fall yet. They're cramming for the finals right now, and I don't think they'll be getting a passing grade.