If you still think that Sallie Mae is just another US agency, you’re behind the times. For a start, its official name, since last year, is SLM Corporation. Nevertheless it’s still widely referred to, even by its own executives, as Sallie Mae. But the name change is just one step the company has taken as it has gradually shifted away from the role it was created for in 1972, to be the chief buyer of student loans originated by other financial institutions.
It still does that, and will continue to do so, but in the 1990s it realized that it was fast becoming a commoditized business and that there would be little if any room for growth. Sallie Mae lobbied Congress to change its mandate, at the same time as the Clinton administration was starting to question the role of government guarantees to the agencies.
Congress finally passed new legislation in 1997 that allowed Sallie Mae to move beyond simply buying up student loans in the secondary market into the more lucrative fee business of originating loans. That has had a marked effect on its business, says SLM’s chief financial officer, Jack Remondi. “Now over 80% of the loans we buy directly, not from other financial institutions,” he says.
That change has had huge consequences for Sallie Mae’s funding requirements. The move to a much more commercial business model meant the end of the implicit government guarantee on the bonds it issues. Congress has given it until 2008 to switch all funding over from the triple-A government-sponsored enterprise into the new single-A corporate entity. Sallie Mae’s executives went one step further, publicly declaring that they would complete the task before 2006.
In the past 12 months it has completed more than half of that transition. “By the end of 2001 49% of our funding was raised outside the GSE,” says Remondi. “We increased that to 54% by the end of 2002, to 58% by March 31 this year, and expect that figure to be in the mid-to high 60s per cent range by December.”
Until last year, most of the non-GSE funding was being done in the asset-backed securities market. It’s due to remain a significant portion of its funding mix: Sallie Mae issued roughly $14 billion of asset-backed securities in 2002, and Remondi expects that to increase this year to around $20 billion.
But in April last year the company finally took the step of issuing its first unsecured benchmark bond with a maturity beyond the September 2006 deadline it imposed on itself for shutting down the GSE. By agency standards the five-year $850 million paper wasn’t a large deal. But it marked the successful start of the campaign to bring the single-A entity to the straight term-debt market. At the time that single-A issuer was called USA Education, a remnant of one of the companies Sallie Mae has bought in the years since Congress changed its mandate.
Later SLM Corp became the official issuer, although of course everyone still refers to it as Sallie Mae.
Remondi and other executives had to get out on the road to explain their story. One of the comments they heard most often at the start, says Remondi, “was the one that we’re just another agency. I’m happy to say that we hardly ever hear that from investors any more.”
By the end of the year SLM had issued $5.5 billion of straight debt and is likely to issue between $6 billion and $7 billion this year. The emphasis was on creating a yield curve as quickly as possible. “After the five-year deal we launched a 10-year and then a 12-year,” says Remondi. “We followed those up with some one-year and three-year paper.”
That might surprise some: last year it raised $23 billion using the triple-A name. But the single-A company needs a full yield curve, and in fact has been issuing short-dated floaters since 2000. And as 2006 draws near, there is less and less that can be done via the GSE; there’s no point issuing anything beyond two years now as it will only have to be refinanced.
This year Remondi and his team are concentrating most of their single-A issuance in three-year, five-year and 12-year maturities.
And they have also managed to tap the convertible market, launching a $2 billion deal in mid-May that adopted pretty much the same structure as Wells Fargo’s deal in January [see Best financial sector borrower]. The main differences are that it is a non-call and non-put four-year deal, rather than a five-year, and doesn’t get quite as good terms: it’s paying five basis points below Libor and has a conversion premium of 75%. Wells Fargo, which has a higher rating and is a better-known issuer, got a 110% premium and is paying Libor minus 25bp.
Appetite for new names Getting such good terms just one year after its first benchmark bond without a government guarantee is pretty impressive. Part of the reason is the environment, explains Peter Brown, who covers SLM in JPMorgan’s debt capital markets group: “It’s basically a new issuer in a market which in 2002 was begging for new names.” Full up on exposures to existing names, and concerned at the number of investment-grade companies becoming fallen angels, many investors were more interested in new names, infrequent borrowers and smaller deals. Remondi says: “Last year was very difficult, especially for financial issuers. But our spreads remained very stable.”
But that’s not all. No other company would get the same terms based on that alone. In fact, says Hany Kamel, who heads Banc of America Securities’ financial institutions origination group: “From a credit standpoint they’ve got a very high level of leverage, roughly 97% to assets. In any other company that would put them into non-investment grade status.”
An asset guarantee What has got SLM a single-A rating is the government guarantee. Not the implicit guarantee on the bonds it issues as a GSE but the explicit guarantee on the assets, the student loans. That only lapses if the servicer of the debt, for which in most cases read SLM, makes a hash of its duties.
That’s what gets the company a single-A rating. And that might be too low, according to Kamel: “It actually trades like a double-A finance company. Their last five-year deal is trading close to 60bp over treasuries.” Matt Basler, who covers SLM for CSFB, says: “Their debt compares very favourably to companies such as Citi, JPMorgan Chase and Bank of America.” It’s traded flat to BofA recently, in fact, even though the Charlotte-based bank is rated three notches higher.
But it’s still rated and traded lower than the GSE, which means that Sallie Mae has had to cope with paying a lot more for its deals. Well, actually, no. “Congress decided in the early 1990s that we had a borrowing benefit as a GSE issuer, so we had a 30 basis point tax, effectively, put on us,” explains Remondi. “So a GSE deal might come at 15bp below Libor, which after the 30bp offset becomes Libor plus 15bp. Our all-in costs for ABS deals are in the low Libor plus 20bp range, and a couple of weeks ago we issued a three-year FRN at Libor plus 17bp reoffer.” There is also the reduced cost of buying student loans now that it can originate them and not just buy them in the secondary market. “Our acquisition costs have reduced to around 1.3% from 2% before.”
The guarantee also works very well for asset-backed deals. In fact, says JPMorgan’s Brown, “if credit card securitizations are solid as a rock, Sallie Mae’s deals are a boulder”. Until recently, most of its ABS deals were pretty straightforward dollar deals set off either 91-day T-bills or 90-day Libor. In the past six months, though, the company has started to add extra features. One is quite simple: a e500 million 18 years and 10 months floating-rate ABS deal priced off three-month Euribor.
It has also issued ABS deals with reset note features. “Some of our portfolios of loans have relatively long lives of 10 to 12 years,” says Remondi. We’ll set the interest rate at three years, whether fixed-rate or floating-rate deals, and the investors take the marketing risk. There’s no credit risk to worry about because of the government guarantee on the loans, so investors aren’t that concerned about the credit profile beyond three years.”
Not only can SLM get a good cost of funds doing these deals, but it also gets to broaden its investor base. “Had we done these deals as a bullet maturity they would have been bought by a different investor base,” says Remondi.
