On Sept. 6, 2008, the U.S. government took Fannie Mae (FNMA, Financial) and Freddie Mac (FMCC, Financial) into conservatorship. Nine days later, Lehman Brothers filed for bankruptcy and the house of cards came crashing down on the housing bubble. Many believe the next recession could be caused by the student loan market.
SLM Corp. (SLM, Financial), or Sallie Mae, is the largest student lender in the country. It makes both guaranteed federal student loans and private loans. It was originally created as a government-sponsored entity in 1972, similar to Freddie Mac and Fannie Mae. However, in 2004, the company terminated its charter and re-emerged as a private sector corporation. At the time, Sallie Mae's stock was trading close to an all-time high, north of $20 a share. It was eventually swept up with the housing bubble, however, and suffered a 95% drop in price between June 2007 and March 2009, down to $1.14 on March 9, 2009.
The housing bubble presented systemic risk where no financial organization was safe. While the derivative market is now bigger than ever with roughly $600 trillion at risk, Sallie Mae's business is in good shape. The company essentially makes derivative bets with its student loans, many guaranteed by the U.S. government at low interest rates. These loans may not be considered derivatives per se, but just like with mortgages, if a student or rather a lot of students fail to pay their loans, that overall market could be at risk.
The good news for SLM and other banks issuing student loans is that, relatively speaking, remains a small market. The $1.2 trillion student debt market is still tiny compared to the overall debt market. In housing alone, there is close to $9 trillion still owed in mortgage loans. Both auto loans and credit cards are now trillion-dollar markets. Additionally, derivative contracts at big banks now total more than $250 trillion.
(Again, the numbers are big because fiat currency (e.g., U.S. dollars) is a commodity and the Federal Reserve has been inflating or expanding the amount of money for decades. Inflation doesn't just come out of thin air.)
Banks like SLM make money issuing debt. The money is lent out and returned with a specific rate of interest attached. Sallie Mae as a private loan originator is in a much better position than Sallie Mae as a government-sponsored entity. The U.S. Department of Education selected Sallie Mae in 2009 to service federal loans on its behalf, but it eventually split into two publicly traded companies in 2014, one that handles the loan servicing called Navient (NAVI, Financial) and one for banking and loan origination, which is SLM Corp.
SLM currently has around 13 million loans and, compared to the best-known financial institutions, looks to be in pretty good shape. Equity as a percentage of total liabilities is in line with both Wells Fargo (WFC, Financial) and Bank of America (BAC, Financial). SLM's loan to deposit rate of 1.24 times is a little high compared to its bank counterparts, which usually hover around 0.75 times. In the last 12 months, SLM generated over $387 million on $1.25 billion in total revenue - that's roughly 5.6% of its outstanding loans.
The company has close to $2 billion in cash and $4.5 billion in long-term debt. All in all, a solid financial holding, especially at this price. The company is expected to earn over $1 a share in 2018 and upwards of $1.20 in 2019. Earnings of $2.20 per share over two years on this $10 stock is a risk worth taking.
Nearly 20 million Americans attend college each year. Of that 20 million, roughly 60% borrow to help cover costs, some taking years or decades to pay it back. As long as our culture favors college degrees over other educational routes and as long as the government continues to guarantee debt on student loans, Sallie Mae will be able to navigate and profit.
Disclosure: I am not long or short any stocks mentioned in this article.
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