University endowments and teachers’ pension funds are among big investors in Sallie Mae, the private lender that has been generating enormous profits thanks to soaring student debt and the climbing cost of education, a Huffington Post review of financial documents has revealed.
The previously unreported investments mean that education professionals are able to profit twice off the same student: first by hiking the cost of tuition, then through dividends and higher valuations on their holdings in Sallie Mae, the largest student lender and loan servicer in the country, which profits by charging relatively high interest rates on its loans and not refinancing high-rate loans after students graduate and get well-paying jobs.
Sallie Mae is a former government-sponsored enterprise that was fully privatized in 2004 and now trades publicly as SLM Corp.
“It’s a conflict of interest,” said Barmak Nassirian, a longtime higher education analyst who most recently served as associate executive director of the American Association of Collegiate Registrars & Admissions Officers. “There is something inherently problematic about benefitting from the financing of the tuition you charge through investments in any lender.”
On average, the annual cost of education at public schools has risen 57 percent since 2005 to nearly $18,000, according to College Board figures Sallie Mae cites in its latest quarterly pitch to investors. Students at private schools are paying more than $39,000, or nearly 44 percent more than they did in 2005.
The so-called “cost of attendance gap”, or the difference between what a four-year degree will cost incoming freshmen versus the amount of government loan money available to them, has risen over the past 10 years by 59 percent to nearly $152,000 for the typical student who started at a private school in 2011, Sallie Mae tells investors. For public school students, the gap has increased 90 percent to about $69,000.
Sallie Mae loans, which are relatively more expensive now than they were before the financial crisis, help “bridge the funding gap,” the company says.
The funds’ investments in Sallie Mae come as Washington policymakers increasingly turn their attention to student debt burdens, weighing stimulative measures that could boost refinancings or increase loan modifications for distressed borrowers, in the face of increasing evidence that student debt is hurting the economy.
The highly profitable company -- it generated a 21 percent return on equity last year -- attributes its earnings in part to the lack of competition in a market in which borrowers’ need for credit is only increasing.
“The margins here are really a function of alternative financing opportunities,” John Remondi, Sallie Mae president and chief operating officer, told investors in January. “And if you think about our products, we're making loans to the parents and students, family education loans. Their alternatives are fairly limited.”
Sallie Mae reported $939 million in net income last year, its highest since 2006. The publicly-traded company, which enjoys a government guarantee on most of its $174 billion in assets, has been profitable in eight of the last 10 years, generating a cumulative $7.3 billion profit.
Its shares have risen 54 percent over the past year, outpacing the 19 percent gain in the Standard & Poor’s 500 Index, America’s benchmark equity gauge.
The endowments of Furman University, Harvard University, Mount Holyoke College, and University of Michigan all hold stakes in Sallie Mae through their investments in Highfields Capital Management, a hedge fund that manages more than $11 billion and is the second-biggest Sallie Mae shareholder. As of the end of last year, Highfields owned nearly 40 million shares of Sallie Mae, or 8.6 percent of the company’s common stock.
Highfield investors, according to securities filings, primarily consist of charitable foundations, endowments, pension plans, and governmental entities, among others. The hedge fund was founded by two top executives of the Harvard Management Co., the Ivy League university's investment arm, which kicked in $500 million to launch the fund.
Pension funds for teachers and other school employees such as the New York State Teachers’ Retirement System, State Teachers Retirement Board of Ohio, Pennsylvania Public School Employees Retirement System, New Mexico Educational Retirement Board, Teacher Retirement System of Texas and California State Teachers Retirement System (CalSTRS) also own significant chunks of Sallie Mae, as does asset manager TIAA-CREF, which oversees retirement funds for teachers, among others.
Highfields Capital declined to comment. The funds either declined to comment or said their ownership stakes were due to passive investments in index funds. Sallie Mae’s shares form part of the S&P 500 and the Russell 3000 Index.
Still, the funds are enjoying bumper returns thanks to their passive investments, aided by borrowers who may be paying more than they would if the student loan market was functioning properly, policymakers have said.
“The issue becomes whether maximizing returns should be tempered by additional concerns and ethical considerations,” Nassirian said of higher-education professionals who have holdings in Sallie Mae. “This form of ‘double-dipping’ can create a very dangerous loop, where you have incentives beyond what you claim in your public rhetoric -- namely to put students into deeper debt.”
“This is a much more subtle and much less mechanistic dysfunction than we have seen in the past,” he added.
In 2006 -- the last year Sallie Mae reported at least $1 billion in profit and enjoyed a return on equity above 20 percent -- student borrowers who took out private Sallie Mae loans that were then securitized were borrowing at interest rates that were about 4.4 to 5.0 percentage points above a benchmark borrowing rate for financial corporations known as the three-month commercial paper rate, according to a review of the company’s bond documents.
For private loans that were securitized last year, students were paying interest rates about 6.8 to 7.5 percentage points above the benchmark corporate rate.
In all, over the last three years the margin enjoyed by Sallie Mae and its investors on private loans the company securitized on average has been about 2 percentage points higher than it was in 2006 relative to the overall corporate borrowing rate.
“Sallie Mae’s private education loans are designed to help students graduate with less debt and pay off their loans faster than other private loan alternatives,” said spokeswoman Patricia Nash Christel. “In fact, we’ve lowered our interest rates three times in the last four years, eliminated origination fees, added borrower-friendly safeguards, and created variable and fixed rate choices as well as in-school payment options to save families money.”
However, the reduction in interest rates for students has not matched the decline in the cost of borrowing throughout the economy. In other words, students are not fully enjoying the benefits of today’s low-interest rate environment, a source of frustration to some government officials.
Martha Holler, another Sallie Mae spokeswoman, disputed the use of commercial paper rates to measure the company’s margins on private student loans. Holler said it would be more appropriate to use the company’s self-reported funding costs specifically related to its private student loan originations, which in the form of long-term equity and debt is more expensive than commercial paper. By that measure, she argued, the company’s margins have slightly decreased since 2006.
But such a measure would exclude the company’s overall cost of funds, which enables the company to finance a wide range of assets more cheaply, boosting earnings. Sallie Mae's cost of funds is substantially lower now than it was in 2006, the year before the credit crunch is widely acknowledged to have started.
Sallie Mae’s preferred measurement also neglects the relative interest rate paid by student borrowers, whose rates in a normally functioning competitive market would move in tandem with interest rates in the broader economy. The commercial paper rate measures the borrowing costs of financial corporations like Sallie Mae, and influences how they price loans offered to households.
In 2012, the company borrowed funds at an average interest rate of 1.45 percent. In 2006 it was 5.37 percent. Interest rates paid by its student borrowers on all of the company’s loan products have not dropped by a corresponding amount, enabling the company as a whole to record a higher spread between its cost to borrow and what it earns off loans to students.
Sallie Mae’s margins also benefit from its Utah-based bank, which since the beginning of 2006 has been responsible for originating and funding “virtually all” of its private student loans, according to the company’s most recent annual report.
The bank relies on deposits to fund student loans. According to Federal Deposit Insurance Corp. data, the bank's cost of funds last year was 1.11 percent.
Sallie Mae’s overall margins have increased to 1.78 percent, from 1.54 percent in 2006.
The Consumer Financial Protection Bureau said in a report on student loan affordability this week that high margins for private student lenders, such as those enjoyed by Sallie Mae, may be due to the lack of options for student borrowers.
“These excess credit spreads may be a symptom of insufficient competition,” the regulator said.
The company originated nearly half of all private student loans in the 2011-2012 academic year, according to a January investor presentation. In addition, it’s responsible for roughly half of all outstanding student loan securities.
Sallie Mae’s low borrowing costs also are aided in part by a borrowing agreement it has with the Federal Home Loan Bank in Des Moines, a government-sponsored entity originally created to provide cheap financing to home mortgage lenders.
As part of its 2010 agreement, Sallie Mae can post government-backed education loans as collateral for credit. At the end of last year, Sallie Mae was able to borrow as much as $8.5 billion.
In the quarter ending March 31 of this year, Sallie Mae had borrowed $2.1 billion with an average interest rate of 0.30 percent. Holler said there was “no connection” between the company’s Federal Home Loan Bank credit facility and private student loans.
The CFPB said it was “worth noting” that Sallie Mae enjoys the use of the government-backed credit facility “at favorable terms,” despite the fact that it “does not originate a noteworthy level of mortgages.”
The CFPB highlighted Sallie Mae in its report, noting the company’s “extraordinary gains” on a federal program designed to aid student borrowers and its apparent reliance on cheap government financing.
For example, the consumer bureau’s report pointed out that a 2008 law called the Ensuring Continued Access to Student Loans Act helped Sallie Mae achieve gains of $284 million in the 2009 fiscal year and $321 million in the 2010 fiscal year off sales of student loans to the Education Department.
The company defended its actions in a statement, saying, “Given the dire circumstances the markets were facing at the time, this intervention afforded 6 million students to access higher education at an extremely low cost to the Department of Education."
The lack of competition for new loans means today’s borrowers are paying higher relative rates, and when they graduate there are fewer opportunities to refinance those loans into cheaper debt.
With increasing exceptions, a student borrower’s credit profile typically improves after graduation, as the borrower has secured a degree and likely a decent-paying job. In theory, an employed college graduate has a better credit score -- meaning he is less likely to default on his debts -- than when he originally took out his education-related loans.
Like a company that has become more profitable and is therefore less likely to default or homeowners who have gained equity in their home since first taking out their mortgage, experts reckon that borrowers with student loans should be able to refinance their high-rate debt as their credit profile improves.
But unlike borrowers with home mortgages, the CFPB has said that borrowers with student loans are unable to “take advantage of today’s historically low interest environment.”
Refinancings of high-rate student loans by Sallie Mae, the biggest student loan company, are scant. “There's not a whole lot of refinancing activity in the private student loan space,” Remondi told investors in January.
Stephen Burd, a senior policy analyst focusing on education at the New America Foundation, a Washington policy group, said that Sallie Mae’s status as an industry leader influences how the broader market operates and could help to explain why refinancings are so infrequent.
“Sallie Mae is the biggest player in this space and if they were doing refinancings, other companies would have to follow their lead to remain competitive,” Burd said.
During U.S. Senate testimony last year, Remondi told lawmakers that students with Sallie Mae loans are benefiting without refinancings because most of the loans are co-signed by parents, and their interest rates generally are dictated by their parents’ credit scores.
“So, to some extent, they're already gaining the benefit of the parental co-signing on that account based on the interest rate at that time,” Remondi said.
“Very rarely do we see interest rates or more loan products being refinanced because the credit profile of the obligor has changed in such dramatic ways that change the overall interest rate structure,” he added. “And I think because of those two reasons, you see a very limited marketplace for private education loan consolidation and refinancing activities.”
In fact, in securities filings the company warns investors that if policymakers provide refinancing opportunities for student borrowers, it could negatively impact earnings, as high-rate debt is paid off and the company’s servicing volumes shrink.
“The adoption and implementation of any such proposals, individually or in combination, could significantly increase our costs, affect our ability to service and collect loans, significantly alter whether or not we remain in certain businesses and the form in which we do so and materially and adversely impact our business, financial condition and results of operations,” Sallie Mae warns investors of potential policy emanating from Washington.
The CFPB suggested this week that policymakers could stimulate refinancing activity by creating a program that would provide lenders such as Sallie Mae with cheap loans that would be secured by newly refinanced student loans as collateral. Such a program could resemble Sallie Mae’s multi-billion dollar credit facility with the Federal Home Loan Bank in Des Moines, for example.
The lack of competition and the prevalence of high-rate loans is having a broader impact than on Sallie Mae’s bottom line. It’s depressing America’s economy.
Millions of student borrowers are paying record relative interest rates on their government loans, according to a HuffPost review, frustrating efforts by the Fed to reduce borrowing costs for households and businesses.
The panel of senior U.S. regulators charged with safeguarding the financial system known as the Financial Stability Oversight Council recently warned that education loans may hamper economic growth and limit home purchases as overly indebted households and young workers cut back on consumption and borrowing. The panel joined the Federal Reserve’s interest rate-setting panel, the Federal Open Market Committee; the Treasury Department’s Office of Financial Research; the CFPB; and the Federal Reserve Bank of New York in alerting about the possible danger student debt poses to either financial stability or the broader economy.
“The whole student loan problem is a problem that should be of deep concern to this body,” cautioned CFPB director Richard Cordray during testimony last month before the Senate Banking Committee. “These are young people that we should care a great deal about.”
Cordray’s agency estimates that Americans owe $1.1 trillion from loans used to finance higher education, exceeding credit card and car loans as the second-largest source of household debt behind home mortgages. About $150 billion of their education borrowings are private, non-government guaranteed loans, roughly a quarter of which are owned by Sallie Mae, according to CFPB data and Sallie Mae’s securities filings.
“They’re the ones with the ambition, aspirations and dreams, and they're getting saddled with debt that they don't understand,” Cordray said of student borrowers. “It's holding them back and it's making them unable to rise and succeed and become leaders in our society.”
He added: “It's a significant problem and we're going to be doing everything that we can to address it at the bureau.”
Some members of the Fed’s rate-setting committee said in March that they viewed “the high level of student debt” as a risk to aggregate household spending over the next three years, posing a downside risk to economic growth, according to meeting minutes.
It was the first time the FOMC, which sets interest rates that affect trillions of dollars of loans and securities, had ever mentioned student loans as a possible risk to the economy, according to a review of past meeting minutes.
New York Fed researchers said last month that younger workers with student debt are less likely than their unburdened peers to have home mortgages or auto loans -- the first time that has been observed in at least 10 years and a worrying development for government officials who have long associated student debt with college education and better-paying jobs.
As policymakers search for solutions to the burgeoning problem of an indebted generation of college graduates, some lawmakers are zeroing in on mandating loan modification schemes or allowing more troubled student borrowers to discharge their unpayable debts in bankruptcy.
Sallie Mae says it supports allowing borrowers to discharge student debt through bankruptcy, subject to certain conditions. A company spokeswoman said that Sallie Mae has modified more than $1 billion in private education loans since 2009 with interest rate reductions or extended repayment terms.
Sallie Mae has already engaged with lawmakers on the issue. Federal records show the company spent more than $1.4 million lobbying members of Congress last quarter.
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