WASHINGTON - Student Loan Marketing Association President Lawrence Hough is closing in on his goal of shedding the federal charter that confines his company to the business of buying and servicing student loans originated by banks.

A bill introduced recently by Rep. Howard McKeon, R-Calif., would free Sallie Mae to form a state-chartered holding company and diversify. A House panel had been scheduled to vote on the measure Wednesday, but postponed action until after Memorial Day.

The bill enjoys broad support, but no matter what happens Mr. Hough still faces obstacles in his quest for new revenue streams.

New government lending programs are crimping Sallie Mae's pipeline of privately funded student loans, dissident shareholders and analysts are questioning the wisdom of shucking the federal charter, and banks are wondering if privatization would turn their longtime student loan partner into a powerful competitor for loan originations, a business off limit the federal charter.

"They're the 1,000-pound gorilla in the student loan business right now," said Bryan Ridley, vice president of educational lending at PNC Bank Corp. in Pittsburgh. "My first-blush reaction is that allowing them to compete directly in loan originations with the advantages they've had is not something that we would view favorably."

As a government-sponsored enterprise, or GSE, Sallie Mae enjoys implicit federal backing in the capital markets, which reduces its borrowing costs to rates about 30 basis points below the rates banks pay.

A liberated Sallie Mae poses no threat to banks, Mr. Hough said in an interview.

"The company has grown to its current size because of its relationships with banks," Mr. Hough explained. "That's a nice marriage, and to disrupt it with a run at loan originations runs counter to logic."

Bankers, though not opposed to privatization, would prefer more concrete assurances that the $50 billion secondary market giant will not muscle into the loan origination market. In a letter to Rep. McKeon, Consumer Bankers Association President Joe Belew suggested that the privatization bill expressly ban Sallie Mae from lending directly to students. The American Bankers Association took a similar position Wednesday.

Mr. Hough did not reject such a restriction, but said it might not sit well with the investors who own Sallie Mae stock and must sign off on privatization.

"I think that we have to be very careful about putting barriers in front of the shareholders who have to vote this thing up or down," he said.

Bank concerns may be the least of Mr. Hough's problems as he steers Sallie Mae through the newly choppy waters of the student loan business. The federal government that created Sallie Mae has lately acted more like an adversary than a benefactor.

A direct government student loan program will kick into high gear this year, taking 40% of the market for federally guaranteed loans away from the banks that sell loans to Sallie Mae. By 1998, direct lending will expand to 60% of the market, threatening future revenue growth at Sallie Mae.

In 1993, Congress squeezed Sallie Mae's profits by slapping a 30 basis- point fee on its loan purchases as the price of the implied federal backing that reduces the company's borrowing costs.

Mr. Hough has a two-pronged plan to reverse Sallie Mae's fortunes. Defending the private student loan system by proving its superiority to direct government lending is the top priority, he said. Improvements such as automated application procedures, flexible repayment schedules, and prompt payment incentives will expand Sallie Mae's share of the secondary market and persuade Congress to roll back direct lending, he predicted.

"I would say we are strong advocates for the bank-based system and have a strong confidence that in the market, in a competitive arena, the bank- based system will prevail," he said.

Diversification into businesses banned by the federal charter forms the second branch of the strategy. Mr. Hough sees opportunities in service businesses that draw on Sallie Mae's expertise in processing paperwork, both in the academic world and elsewhere.

"We're pretty good at supporting systems and processing and paper- intensive functions," Mr. Hough said. "I look forward to working with a broader charter that allows me to help fashion solutions for the paperwork associated with financial aid applications and the bursar's functions and the registrar's functions."

Processing health care claims looks like a logical extension of the company's skills, Mr. Hough observed, noting similarities to student-loan servicing, which Sallie Mae grew into a $225 million annual business in 15 years.

"I think we could enter the health-care processing business in a very slow and thoughtful way and, in time, reach those same kinds of volume and growth, probably on an accelerated basis - I don't think it would take us 15 years," he said.

As logical as the plan may sound, abandoning the benefits of government sponsorship to pursue unproven new ventures strikes some as unwise.

A group of dissident shareholders led by former Sallie Mae executive Albert Lord wants the company to keep the federal charter, shrink its balance sheet through loan sales and a spin-off of the servicing business, and return the proceeds to the shareholders. A showdown is set for the company's annual meeting May 25, when shareholders will choose between slates of board candidates backed by the insurgents and management.

Analysts questioned whether revenues from the new businesses would offset the benefits that will be lost if Sallie Mae forsakes government sponsorship.

"I wonder if those businesses are sizable enough and profitable enough to justify giving up the GSE charter," said Thomas O'Donnell, a Smith Barney Inc. analyst who follows Sallie Mae.

Two immediate effects of privatization would be an increase of around 30 basis points in borrowing costs and a need to raise capital reserves by about 65 percent, Mr. Hough acknowledged. To avoid the massive earnings hit these changes could cause, Mr. Hough plans to sell off Sallie Mae's entire $30 billion portfolio of student loans in a securitization.

The portfolio would be a huge chunk for Wall Street to swallow, but Jonathan Gray of Sanford C. Bernstein & Co. thinks the market has the appetite for it.

"It all depends on securitization, and it's never been done, (but) I believe they will be successful," Mr. Gray said.

Regardless of its merits, privatization comes with a price tag attached. The McKeon bill requires Sallie Mae to buy its freedom by issuing warrants exercisable for 100,000 shares to the government.

Still to be resolved is the problem of how to reimburse the government for the revenue lost when privatization relieves Sallie Mae of the 30 basis-point fee it has been paying for GSE status. Congressional budget rules require that all new legislation be "revenue neutral" -in other words, not cost the government money. So Sallie Mae must find revenue to offset the government's loss of the fee.

Mr. Hough declined to discuss specific proposals for reimbursing the government, which he said are under discussion. But he dismissed as a red herring bank concerns that the government will force the industry to make up the shortfall, perhaps by raising guarantee fees paid by banks on student loans.

"It will not be a solution on anyone's back but ours," Mr. Hough promised.

Mr. Cahill writes for the Medill News Service.

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