Citigroup Inc.'s sale of its student-loan business may signal the beginning of a wave of consolidation among private lenders who were cut out of the federal college student-loan program this summer.
Legislation that went into effect July 1 prohibits private lenders from making federal student loans, essentially forcing those lenders to move from originating loans to servicing them. All federal education loans now come through the government's Direct Loan program.
"I expect we're going to see a lot more mergers and acquisitions over the next 12 months," said Mark Kantrowitz, publisher of the FinAid.org website, which provides research and information for students seeking financial aid.
"If you can get the portfolio cheap, you can make money off it if you service the loans efficiently," he said.
SLM Corp., better known as Sallie Mae, is buying $28 billion of Student Loan Corp.'s federally funded student loans while Discover Financial Services, already a player in the market, will take $4 billion of private student loans. Student Loan Corp. is an indirect subsidiary of Citi; 80% of it is owned by Citibank and 20% is publicly traded.
The deal in essence means Sallie Mae, the nation's largest student-loan provider, bought the bulk of Student Loan Corp., the No. 2 lender. For the borrowers who owe money on those student loans, their loan terms won't change.
Kantrowitz predicted that, as a result of the new law, smaller lenders would either get out of the business altogether or merge with other small lenders because the cost of servicing loans drops with volume.
Kantrowitz said he expects most M&A activity will be in the next year because loans lose their value as they mature. Four years from now, for example, the revenues off the portfolio will be about half of what they are now.
Discover, which Kantrowitz said has a strong track record of servicing loans, wants to build that business for its flow of revenue as well as a source for its credit-card business.
The purchase "significantly accelerates our participation in the private-loan business," Discover Chief Executive David Nelms told Dow Jones Newswires.
"It gives us a platform that's very strong and gives us a more mature business," he said. "It's not often that you can do an acquisition that is such a great fit and" immediately boosts earnings.