Student Loan Marketing Association
Student Loan Marketing Association
1050 Thomas Jefferson Street, NW
Washington, D.C. 20007
Assets: $28.63 billion
Stock Index: New York
Although the Student Loan Marketing Association, better known as Sallie Mae, was created by Congress, it is a publicly owned, for-profit company. Sallie Mae was created in 1972 to provide a secondary market for the exchange of federally insured, guaranteed student loans. Congress created Sallie Mae to make student loans more liquid, and therefore give lenders a greater incentive to participate in the Guaranteed Student Loan Program (GSLP). Edward A. Fox has been president and CEO of Sallie Mae since its inception. His conservative fiscal policies are given credit for the company’s remarkable success.
Sallie Mae’s pool of voting stockholders is restricted by Congress: only banks and colleges eligible to participate in its programs can own voting shares in Sallie Mae, although its nonvoting shares are unrestricted. Sallie Mae’s board of directors represents the three institutions with which it is involved: financial, educational, and governmental. Financial institutions holding voting stock elect seven directors, as do educational institutions, while the president of the United States appoints seven more and chooses the chairperson.
Sallie Mae began by offering two basic services: loan purchases and warehousing advances (secured loans and lines of credit). By purchasing student loans, Sallie Mae offers lenders liquidity; the knowledge that they can sell the loans and are not required to use the money to make new student loans makes lenders less nervous about tying up money in student loans in the first place. Under its warehousing program Sallie Mae lends financial institutions money to make new student loans by accepting existing loans or other government securities as collateral.
Guaranteed student loans are a special market for several reasons. The Guaranteed Student Loan Program, created in 1965 by the Higher Education Act, was established to supplement the government’s grant and work-study programs, which help students finance higher education. Under the GSLP, the federal government assumes the risk for defaulted student loans. Originally, the government guaranteed the loans directly, but now state and nonprofit agencies directly insure the loans, backed up by federal reinsurance.
The GSLP allows qualified students to borrow a certain amount at a special fixed interest rate each year they are in school. While students are in school and for a short grace period after they leave, the federal government pays the interest on their loans, so that a student must pay back only the principal plus the interest accrued after graduation. In addition, the government pays a special allowance to lenders to make up the difference between the low rate of interest students pay and the market rate of return. Today this allowance is set at 3.25% above the 90-day treasury bill rate. The borrowing rate for students is 8%, so, for example, if the treasury bill rate is 10%, lenders get the 2% difference between that rate and the 8% students pay, plus 3.25% on top, adjusted quarterly according to the treasury bill rate.
Since collection procedures make carrying student loans costly once they reach the repayment phase, many lenders sell student loans to Sallie Mae when the student graduates. Student loans are costly not because student default rates are high (defaults are guaranteed by the government anyway) but because they are relatively small loans that require a lot of work. In addition to the federal collection and reporting requirements that must be followed to qualify for the government guarantee in the case of default, student loans are often complicated to keep track of; for example, students must be granted deferments for unemployment, return to school, or any of a host of other reasons.
Sallie Mae’s high volume means that the company can administer the collection of loans with greater cost effectiveness—in 1988, Sallie Mae held 24% of all outstanding student loans. Thus, Sallie Mae ensures an adequate supply of credit for educational needs by enabling lenders to hold onto their loans during the lucrative in-school phase, sell the loans when they begin to require more attention, and use the money to make new loans.
But one of the reasons many lenders are willing to lend to students to begin with is that students make a very attractive pool of future customers. Therefore, some banks prefer to hold onto their loans. For them, Sallie Mae also offers services to make processing the loans easier. Its automated portfolio systems, both on site (PortSS) and off site (ExportSS), offer operational support to guide lenders through the life of a loan.
As a federally chartered corporation, Sallie Mae’s history has been shaped by legislation. After adjusting the interest rates and special allowances for GSLP borrowers and lenders for several years in its efforts to make enough educational credit available, Congress chartered Sallie Mae in 1972 to create a secondary market for student loans. The company opened for business in 1973 with financing from Washington, D.C. banks, repaying these loans through the sale of federally guaranteed securities the same year. After that, Sallie Mae depended on financing from the Federal Financing Bank, an arm of the Treasury Department, where it could borrow money at very attractive rates. But Congress never intended Sallie Mae to be government supported, and in 1981 Sallie Mae started raising the money it needed on public capital markets. Since then, it has become known for its inventive financing schemes, designed to lock in floating-rate liabilities to match its floating-rate assets.
In 1974, Sallie Mae made its first issue of common stock, raising $24 million in capital. The sale of this stock was restricted to banks or educational institutions, who were required to buy 100 shares in order to participate in Sallie Mae’s programs (this requirement was later lowered to 50 shares, and small institutions are exempt).
In 1976, the lender allowance was tied to the 90-day treasury bill rate and its ceiling was raised from 3% to 5%. That year, in an effort to reduce the red tape and inefficiencies that often accompany federal programs, the government transferred responsibility for the GSLP to the states and encouraged them to set up their own guaranteeing agencies. It also authorized Sallie Mae to buy loans originated under a newly created Health Education Assistance Loan Program (HEAL) to help graduate students in the health professions finance their educations.
By 1977, Sallie Mae was able to issue its first dividend. The next year, the Middle Income Assistance Act removed all income restrictions for student borrowers in response to complaints from middle-income families that they were too rich to get assistance but too poor to pay rising education costs, especially if they had more than one child in college at a time. Since students were no longer required to demonstrate financial need to qualify for loans, the program expanded rapidly—from $2 billion in new loans in 1978 to $3 billion in 1979 to $8 billion in 1980. In 1978 Congress also removed the ceiling on the special allowance to lenders, setting the allowance simply at 3.5% above the 90-day treasury bill rate, so that lenders were guaranteed a market rate of return. That and the elimination of the paperwork involved in determining eligibility made student loans more attractive to lenders. Sallie Mae grew accordingly, from assets of $1.6 billion in 1979 to $7.5 billion in 1982.
In 1980, as a prime rate near 20% pushed the cost of the GSLP sky-high, Congress made further amendments to the Higher Education Act. For the first time since 1968, the interest rate charged to student borrowers was raised, from 7% to 9%, for as long as treasury bill rates remained at a certain level (this rate stayed at 9% until 1983, when treasury bill rates fell enough to lower the rate to 8%). The amendments of 1980 also established a new educational lending program called PLUS, for parents of dependent students.
More important to Sallie Mae, however, were changes that increased the company’s range of operations and gave it new ways of raising capital, to begin weaning it from federal support. Congress set the expiration of Sallie Mae’s authority to issue federally guaranteed obligations for 1984, but gave the secretary of the treasury power to buy as much as $1 billion of nonguaranteed Sallie Mae securities and authorized Sallie Mae to issue nonvoting common stock.
Congress also broadened the services Sallie Mae could offer, giving the company much greater flexibility in making warehousing advances by loosening the restrictions on what Sallie Mae could accept as collateral for them and by liberalizing the requirement that warehousing advances go directly back into student loans. Sallie Mae was also permitted to consolidate or refinance loans for highly indebted students; to make advances to state and other nonprofit agencies for their student loan operations; and to make loans directly to students in areas of the country where there was insufficient credit available.
In 1981, under the new Reagan administration, Congress reinstated a needs test for borrowers with a family income above $30,000 and pushed Sallie Mae to lessen its reliance on federal funds more quickly. Accordingly, expiration of Sallie Mae’s authority to issue federally guaranteed obligations was moved up to 1982, and in mid-1981 Sallie Mae made its first public offering, of short-term discount notes.
Congress also continued to broaden Sallie Mae’s activities, authorizing the company to deal with educational loans not insured by the GSLP and to buy and sell the obligations of state and nonprofit educational-loan agencies.
During the 1980s, Sallie Mae experimented with ways of raising funds at as low a cost as possible. Since all of its assets—the student loans it has bought and the warehousing advances it has made—earn a floating rate of interest tied to the 90-day treasury bill rate, Sallie Mae prefers to borrow money at a floating rate tied to the same indicator. The company has been very successful at doing this. With both assets and liabilities tied to the treasury bill rate, Sallie Mae is insensitive to changes in the interest rate; as a quasi-governmental agency whose assets (those same student loans) are guaranteed by the federal government, Sallie Mae is able to raise money easily and fairly cheaply. As the cost of education has continued to out distance inflation, student loans have continued to be in heavy demand, so Sallie Mae’s assets have grown at a breakneck pace: from $1.6 billion in 1979 to $28.63 billion in 1988, an increase of nearly 1,700%. And to Sallie Mae, which makes its money on the fixed spread between its floating-rate assets and floating-rate liabilities, increased assets mean increased profits.
In April, 1983 Sallie Mae made its first offering of preferred stock, and in September of that year it made its initial offering of nonvoting common stock, thus becoming a publicly owned company. Though the company has lobbied for permission to give voting power to all its common stock, it has so far been unsuccessful.
In 1986, when Congress reauthorized the Higher Education Act of 1965, it again broadened Sallie Mae’s range of operations, while requiring a needs test for all loan applicants, even those with family incomes of less than $30,000, and lowering the allowance to lenders to 3.25% above the treasury bill rate. Sallie Mae was given the latitude to deal in loans to educational institutions for physical improvements. Congress also authorized the establishment of the College Construction Loan Insurance Association (Connie Lee) to provide insurance for loans to academic institutions for facilities. Sallie Mae helped set up Connie Lee, which opened for business in 1988.
Student loans are a high-volume, low-margin business. Sallie Mae’s status as the largest (and the only national) secondary market for these loans gives it the volume it needs to maximize that margin and make student loans a viable business. While it will always be subject to legislative regulation and the whims of Congress, the growing recognition of the importance of higher education in maintaining America’s competitiveness in world markets and the continually rising costs of that education assures a sound future for Sallie Mae.