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Will Student Lenders Still Make the Grade?

The worst has passed, but we think student lenders' glory days are done.

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As recently as 2007, student lenders were some of the most profitable financial services companies in our coverage universe. With guaranteed loan spreads and up to 100% of losses reimbursed by the government, companies could lever up and achieve extremely high returns on equity. However, relatively small changes in legislation passed during the summer of 2007 put student lenders on the defensive, and the simultaneous credit crunch amounted to nearly a knockout blow. So far, the companies have survived the assault, but we don't think they will ever be the same. In fact, with Congress debating a proposal to end the Federal Family Education Loan Program ("FFELP") and originate all loans directly from the government, student lenders are increasingly turning to new sources of income. Unfortunately, none of these seem poised to produce the profits that lending once did.

Servicing Contracts Only a Consolation Prize
FFELP loans still make up most balance sheet assets for  Sallie Mae (SLM),  Nelnet (NNI), and  Student Loan Corporation (STU), but this will probably not be the case for long. With the securitization market shut down, student lenders were nearly unable to finance even guaranteed loans during the credit crisis. Congress and the Department of Education came to their rescue with the Ensuring Continued Access to Student Loans Act (ECASLA) in late 2008, providing funding through the Department of Education and allowing lenders to continue originating loans. Later, during the summer of 2009, the Department of Education announced that Sallie Mae and Nelnet were two of the companies awarded servicing contracts for loans sold to the Department under this program. While clearly a win for these companies, the contract was neither a windfall nor a long-term solution, in our opinion. We doubt that these servicing contracts will prove to be extremely profitable, and are concerned that financial success for the servicers will result in unfavorable changes to future arrangements. Indeed, changes are already afoot in Congress that will have major effects on the future of student lending.

Jim Sinegal does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.