Final Trade Detail
- Sallie Mae is now originating unsecured Personal Loans. Their appetite for risk is becoming more reckless.
- Rising interest rates will likely result in increased defaults and payment deferrals.
Sallie Mae hasn’t learned from its mistakes.
And neither has its investors.
Had you invested in Sallie Mae in June 2007, you would’ve lost 92% of your money just 2 years later.
At the time Sallie Mae was trading north of $20/share. Less than two years later shares were cratering, eventually dropping to a low of $1.58 on March 13, 2009. It would have gone to $0 had it not been for a government bailout.
Investors seem to think Sallie Mae has improved its finances. Its lending practices. But it hasn’t. Its whole business model is flawed and risks to its lending portfolio are mounting.
The unfortunate tale of this story is that history is likely to repeat itself again. Let me explain.
Sallie Mae’s Business Model
Sallie Mae provides loans to its student borrowers. They earn money by charging borrowers a fixed or variable interest rate on the borrowed funds. Today they’re the largest player in the private student loan industry – with 55% market share. And Salle Mae has grown its private student loan by 65% over the past two years to $17.5 billion.
Here’s how they make money:
Most students begin to repay their student loans immediately after graduating with a degree.
It has been smooth sailing for Sallie Mae over the past few years. A low unemployment rate combined with low interest rates made it easier for borrowers to make their monthly payments. That may not be the case going forward.
Rising Interest Rates
Nearly a quarter of student loan borrowers are currently in a state of delinquency or default. That number is projected to rise – nearly 40 percent of borrowers are expected to fall behind on their loans by 2023 according to the Brookings Institute.
Think about that for a second. One out of every four student loans are past due or lenders have given up on them. That’ll rise to four in 10 borrowers in just four years.
The worst part: Sallie Mae’s variable interest rate loans represent 74% of their portfolio.
The cost of repaying those loans will increase for borrowers as interest rates rise. This forces many borrowers to make a tough decision: a) pay even if you can’t afford it; b) miss payments and ruin your credit score; or c) defer payments and allow interest to accrue each month.
For many, Option C is the only logical choice. Unfortunately, the disaster that ensues with Option C is all too real for many borrowers.
Let’s take Claude Richardson who was recently featured in an article on CNBC.
Claude Richardson returned to college in the hopes of finding himself a new career. He attended two for-profit schools — the University of Phoenix online, and the New England Institute of Art. He said the education at both schools proved disappointing, and he never found a job in his field of study, information technology.
Instead, the 65-year-old man works 60 hours a week as a driver for a transportation company. He makes $8 an hour. He can’t remember the last time he took a vacation. He doesn’t pay for cable, since he has no free time to relax in front of a television.
He feels helpless when he looks at his student loan balance of more than $160,000. He has defaulted multiple times. “If I could pay, I would,” Richardson said.
Sallie Mae would argue that this is a rare situation, and most of their borrowers have an average FICO of 740, often including a parental co-signer. Well, according to Brookings Institute, parents who entered repayment in 2000 paid down 56% of their loan balance within five years. Those who started repaying their loans in 2009 only paid down 36% during the first five years. It’s simply becoming more difficult to afford the cost of higher education.
“Let’s Take On More Risk”
As we’ve outlined, rising interest rates paint a worrisome picture for the student loan lender. Many companies in this position would become more risk averse. Not Sallie Mae. Their appetite for risk has only increased, and they’re now providing unsecured private loans to student lenders. Sallie Mae originated $260 million in personal loans during the first nine months of 2018, acquiring an additional $703 million from third parties during that period. That’s nearly $1 billion in unsecured debt!
Unlike a mortgage where lenders have physical property to repossess, there are no major financial repercussions for not repaying a Sallie Mae loan.
Are students going to hand back their diplomas?
We only have two words to describe this behavior: “Totally Reckless!”
Sallie Mae continues to prove that it will accept more risk amidst growing repayment concerns. This is a recipe for disaster. We suggest shorting the stock above $10/share. Your target is $7.50/share, representing a 25% gain (ex-dividends).
It’s always prudent to include a stop-loss, in this case $12.00/share.