Sallie Mae Q3 '96
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Sallie Mae Q3 '96
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(FOOL CONFERENCE CALL SYNOPSIS)* By Dale Wettlaufer (MF Raleigh)
STUDENT LOAN MARKETING ASSOCIATION (SALLIE MAE) <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLM)") else Response.Write("(NYSE: SLM)") end if %> ALEXANDRIA, Va., October 13, 1996/FOOLWIRE/-- Sallie Mae reported on October 10, 1996 net income of $1.79 per common share for the third quarter of fiscal 1996 ended Sept. 30, 1996, up 17 percent from $1.28 per share in the year ago quarter and down slightly from $1.79 per share, in the prior quarter.
Growth in net income over the 1995 third quarter was primarily a result of 11 percent growth in managed student loan assets, significantly lower operating and servicing expenses, and higher net floor revenues. Per share results further benefited from the corporation's ongoing share repurchase program, including 1.1 million shares repurchased during the third quarter of 1996.
Core net income (earnings net of recognized floor revenues) for the 1996 third quarter was $97.3 million -- $1.71 per share -- up 12 percent from $86.6 million, or $1.28 per share, for the 1995 third quarter and up 4 percent from $94.0 million, or $1.63 per share, for the 1996 second quarter. The increase in earnings was attributable to increase in loan volumes, lower operating expenses, and lower servicing expenses relative to the year-ago and prior quarters.
Purchase volume for the quarter was $1.8 billion, 14% lower than the year-ago quarter. Year-to-date purchases are 90% of the comparable period in 1995. The lag behind 1995 levels will be rectified as the company adds in the results of the restructuring of the Chase relationship. Third quarter purchases do not reflect student loan volume related to the successful renegotiation of Sallie Mae's relationship with The Chase Manhattan Bank completed in September 1996. Chase's existing $2.6 billion student loan portfolio was effectively transferred to a joint venture, in which Sallie Mae has a 50 percent participation, effective Oct. 1, 1996.
Looking at the market going forward, the company is still in the midst of the heavy lending season. Preliminary numbers are showing continued growth in share of self-origination and a leveling off of the steep growth in direct-lending penetration. However, note guarantees declined 10% in federal fiscal year 1995 and are expected to decrease in federal fiscal year 1996. Clearly, this will effect the pool of loans available for sale in 1997.
As bank inventories of loans decline, sales into the spot market have tightened. Therefore, Sallie Mae's committed purchases continue to gain in importance in building the student loan business. The investments the company made to build this pipeline have been worth it. The company aims to achieve single-digit purchase growth in 1997 over the 1996 level. Given the decrease in 1996 self-originations, this will be a challenge. The company expects the single-digit purchase growth to be exclusive of the one-time liquidation the company saw from the restructuring of the Chase transaction.
Servicing fees declined from 58 to 54 basis points (one basis point = 1/100th of a percentage point) from the second to third quarters. This drop contributed half of the $0.08 increase in core EPS. The remaining $0.04 cents EPS came from student loan volume and share repurchases. Servicing expenses continued to decline, but at a smaller pace. A 10% decline in servicing fees is reasonable over the next 12 to 18 months.
Operating expenses were $32.5 million in the quarter, down $1.2 million, or 4%, from the prior quarter and down $14.8 million, or 31% from Q3 1995. The $1.2 million decrease relative to the prior quarter is due to lower salaries and lower advertising and printing expenses. Year-to-date 1996 operating expenses were $96.4 million. The company will meet its stated goal of coming in at, or slightly below, $130 million for 1996 operating expense.
Floor revenues represent additional income the corporation receives on certain loans in low interest rate environments. The corporation recognized as income $3.9 million, after-tax, of net floor revenues for the third quarter of 1996, down from $9.0 million in the second quarter of 1996. No floor income was recognized in last year's third quarter.
Net income for the nine months ended Sept. 30, 1996 was $307.1 million, or $5.32 per share, compared to $393.5 million, or $5.51 per share, for the same period last year, which included $130.1 million, or $1.86 per share, related to a change in method of accounting.
The corporation changed its accounting method of deferring a portion of the income it earns on student loans in the fourth quarter of 1995. Generally accepted accounting principles require that the cumulative effect of the change in accounting method be reflected as of the beginning of the year the change is made. Therefore, reported EPS for the third quarter of 1995 of $1.28 include $.08 representing the effect of the accounting change for that period.
The total portfolio of loans managed at Sept. 30, 1996 grew to $37.9 billion (including $5.0 billion of securitized loans), up 11 percent over $34.3 billion at Sept. 30, 1995. Sallie Mae purchased $1.8 billion of student loans in the third quarter of 1996, down from $2.1 billion in the year ago quarter, reflecting the impact of the government's direct student loan program. Volume for the year totals $6 billion.
Loans purchased from lenders using Sallie Mae's ExportSS(R) service totaled 54 percent, or $1.0 billion, of the third quarter's loan purchases compared to 47 percent, or $1.0 billion, a year ago. A hallmark of the corporation's marketing strategy, ExportSS is Sallie Mae's loan origination and administration service for lenders who choose to outsource their student loan operations and commit to sell their loans to Sallie Mae.
Despite substantial growth in direct government lending's share of national student loan originations, the ExportSS pipeline of loans currently serviced and committed for sale to Sallie Mae was $3.8 billion at Sept. 30, 1996, down only 5 percent from $4.0 billion a year ago.
The company purchased 1.1 million shares in the quarter, bringing year-to-date volume of share repurchases to 3.8 million, or 7% of shares outstanding at year-end 1995.
The poor student loan spread increased from 170 basis points to 177 BP. Four of the seven BPs resulted from the decrease in servicing fees and the remainder is due to the gain on securitization. However, the positive income contribution from increases in student loan spreads due to securitization are offset by the loss in earning assets.
On Sept. 30, 1996, Congress passed, and President Clinton signed, legislation authorizing Sallie Mae to restructure as a fully private, state-chartered corporation. The legislation permits the Board of Directors to adopt a plan to reorganize Sallie Mae and requires the corporation to submit the plan for shareholder approval within 18 months. The corporation anticipates bringing the privatization plan to a shareholder vote in mid-1997.
The company set forth a few years ago some of criteria by which it would judge successful a privitization plan. These included: no material exit fee, no restrictions on business diversification, and grandfathering of all GSE debt outstanding. All of these were achieved. The legislation also provides for a 12-year transition period with full access to GSE attributes over that period. The legislation increases the range of strategic options available to Sallie Mae.
"This quarter's strong operating performance, coupled with enactment of legislation authorizing the privatization of Sallie Mae, demonstrate that management's execution of its overall strategy continues to yield substantial benefits for Sallie Mae shareholders," said Lawrence A. Hough, president and chief executive officer. "We believe that privatization will give us the ability to apply our considerable marketing, processing and financial skills in new, creative ways to benefit consumers and to increase our franchise value."
Sallie Mae will be gradually transformed into a "pipeline securitizer" with an array of fee-based services that meet the needs of customers while capitalizing on the opportunity presented by the company's prowess in processing and technology. The company's client-focused strategy will allow Sallie Mae to strengthen its preferred supplier status. This strategy is critical to Sallie Mae's ability to secure the volume that feeds the securitization pipeline and to leverage its servicing expertise.
The restructuring of the Chase relationship during the quarter is a good example of the success of the preferred provider strategy, in that financial institutions want valued-added student loan products and best-in-class lending services. By partnering with the largest retail and education finance lender in the country, Sallie Mae realizes several benefits. First, the company secured a key distribution channel. Second, Sallie Mae obtained servicing rights to all volume generated the Chase-Sallie Mae joint venture. Last, the company will enjoy the ecnomies of scale that those servicing rights will provide. The venture agreement also transformed a term transaction into a perpetual transaction. "This transaction was clearly additive to shareholder value."
The company has long believed that its back office capabilities and technologies can be applied to applications beyond student loans. Recent devlopments suggest that the company has been correct in this belief. During the quarter, the company secured two contracts to administer state pre-paid tuition plans. The company is also currently bidding on the right to collect on defaulted student loans on behalf of the federal government. Those these would be small revenue items right now, the company wants to demonstrate the ability to generate fee-based revenue streams which make use of the Sallie Mae's back-office capabilities. The company won two court cases in the quarter, one of which will result in a $9 million pre-tax gain in the fourth quarter.
II. QUESTION AND ANSWER SESSION
The decline in spread (between loans the company is buying and federal obligations) on student loans is declining right now and the company expects that it will be flat in the coming year. The spread is currently in the vicinity of 120 basis points from like-maturity federal obligations. The spread includes service fees and a floor on rates.
In the coming fiscal year, the company will hold general and administrative expense to $130 million, or flat with this year. The investments made in building the pipeline have been the most intelligent strategic use of discretionary spending.
The goal on securitization in fiscal 1996 has been $6-8 billion. Through three quarters, the company is at $6 billion. The goal next year is $6 billion+.
In terms of the spot market, the bond market is becoming tight as inventories dry up due to decreases in self-originations in federal fiscal year 1995 and 1996. Competition has intensified. In terms of seecuritization for next year, there will be more done in 1997 than in 1996, by a 10-20% margin.
Gains on securitization going forward will be somewhere between 50 and 100 BP, depending on the characterisitics of the portolio in the future. To judge the size of the company's portfolio, investors should look at the average size of the portfolio, not the beginning or ending balances alone.
If there is more direct lending in the market in the near future, the company believes that it can compete with in the market. The company believes that market competition will prevail no matter what the political landscape looks like in the future. The company sees year 3 direct lending achieving market share of the 35-40% penetration set out by legislative changes in Congress. The company sees a slowing in the rate of growth of direct lending at this time.
The company sees a larger propensity for direct lending coming out of public schools than private. Proprietary schools are also seeing more direct lending than private.
The company expects to see market growth for federal student loans over the next five years to compound at 7-8%. The company wouldn't commit to estimating the re-authorization levels of the 1997 legislation. * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. |
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Copyright 1996, The Motley Fool |