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The Department of Education has selected student lender Sallie Maeand three other companies to service the $550 billion in outstanding federal student loans and future loans owned by the government.
Reston, Va.-based Sallie Mae is the country's biggest student lender. It stock surged 39 cents, or 5.1 percent, to $8.08 in afternoon trading Thursday.
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The new contract announced Wednesday may help Sallie Mae offset the loss of income if the government, as President Barack Obama wants, stops subsidizing the government-guaranteed loans that make up the bulk of Sallie Mae's portfolio.
FBR Capital Markets analyst Matthew Snowling said the contract award is a "big win" for Sallie Mae. It allows Sallie Mae to convert its business model from a lender to a servicer if Obama's plan becomes reality. If the president's budget is adopted, Sallie Mae would no longer be a big provider of student loans.
"Winning one of these four spots was certainly a make-or-break decision," Snowling said.
The contract is for the managing of federal student loans owned by the Department of Education and does not include loan origination. The five-year contract is expected to start in August, according to Sallie Mae. The government may renew it for one five-year term.
Servicing a loan involves the administrative aspect of lending—sending monthly statements, collecting payments and managing delinquencies.
The government said the minimum contract award for "compliant and performing" lenders is valued at $5 million, with maximum assignments of up to 50 million student borrowers per lender over the five-year contract.
Investors have become concerned about Sallie Mae's liquidity and funding situation as its loan losses mounted and the Obama administration in its fiscal 2010 budget spelled out plans to shift the way students get loans. Rather than subsidizing private lenders, the government would originate all college loans itself.
Under that plan, Sallie Mae's portfolio would be more reliant on private loans not guaranteed against default by the government.
In its first quarter, Sallie Mae originated a record $6.6 billion of government-backed loans. Private loan originations, which carry higher interest rates, were $1.5 billion.
Sallie Mae has been hurt by rising loan losses. CEO Albert Lord earlier this month that loan charge-offs, which are loans written off as not being repaid, will peak this year and stay high next year.
"As a loan processing company, SLM may generate less net income than as a lender," wrote William Blair & Co. analyst David Long in a research note earlier this month. If the company converted its entire government-guaranteed loan portfolio into a servicing-only relationship, however, and losses from private loans stabilized, the company could still earn more than $1 per share a year, he said.
There's still a lot of uncertainty, Snowling said. Congress has to go over the legislation, and it is unknown how many new loans would even be sold to the government from private lenders.
Still, Sallie Mae currently has about a $150 billion portfolio of subsidized government loans. Winding that down over the next decade would free up a lot of capital, Snowling said, generating cash flow to reinvest in other businesses.
Sallie Mae has taken steps to fortify its liquidity position. It said in May that it trust priced $2.6 billion in private loan securities through the Term Asset-Backed Securities Loan Facility, or TALF in May. TALF is the Fed's program meant to spark lending to consumers and small businesses.
Also named under the contract was Lincoln, Neb.-based student lender NelNet, whose shares rose $1.94, or 23.8 percent, to $10.08; AES/PHEAA of Harrisburg, Pa.; and Madison, Wis.-based Great Lakes Education Loan Services.
For Nelnet, a much smaller company, winning the contract "moves the needle a lot," Snowling said. Having access to 25 percent of the government's portfolio would be extremely important for the company.