A year after Congress gutted its business, the student loan giant wants to be freed of its government sponsorship. But it faces an uphill battle.

WASHINGTON -- Like many of the college graduates whose education is has financed, Sallie Mae faces an uncertain future.

Until last year, the Student Loan Marketing Association (as Sallie Mae is officially known) was envied as the leader in the secondary market for the student loans it created. Its consistent profits made it a favorite on Wall Street, where its stock hit a two-decade high.

Then, Sallie Mae became a victim of its own success. After years of criticism that million-dollar executive salaries and fashionable Georgetown offices were funded with fat profits from the federally guaranteed loan program, Congress changed the future.

Direct Lending Program

Lawmakers approved a plan that, beginning this summer, puts the U.S. Department of Education in the direct lending business, while putting a limit on the arguably generous margins that Sallie Mae and its bank partners had.

Even though Sallie Mae plans to stay in the secondary market, the agency is clearly planning for the future -- one that it hopes will include full privatization as early as 1995.

Executives make no secret of their ambition to be the first government-sponsored enterprise to shake the restrictions of its federal charter.

"You continue to look at your options," said Tim Greene, executive vice president and general counsel at Sallie Mae. "I think competition is healthy, but we don't want to compete on originations. We are looking at diversification, just like the banks are."

Deliberate Vagueness

Those who have followed the agency for years say that Sallie Mae is just being a smart political operator by being ambiguous about its plans.

"They're not likely to be specific about the future because it may potentially create opposition to the privatization," said Peter Treadway, an analyst at Smith Barney Shearson Inc.

The loudest voices against privatization may be those of bankers, who have long sold loans to the agency. Indeed, Sallie Mae officials repeatedly insisted during interviews that bankers will remain vital partners, regardless of whether the agency privatizes.

"Our intention is to support banks and their involvement in this business," said Lydia Marshall, executive vice president for marketing at Sallie Mae.

Competitive Threat Seen

But many are not buying it. They point out that Sallie Mae has historically edged toward direct lending. Some believe that, once freed from its federal charter, the agency would be able to quickly use its relations with universities across the country to originate loans while continuing to profitably make a secondary market for others.

"The bankers are concerned that they will have yet another large, nonbank competitor," said Joe Belew, president of the Virginia-based Consumer Bankers Association, which includes hundreds of student loan lenders. "The issue is how far will they grow into traditional banking areas if they privatize."

He adds: "They have a history of leaning toward direct lending. This is not a new issue."

In 1984, Sallie paid $3.4 million for a North Carolina thrift it renamed First Capital Corp. The agency said its intent was to provide supplementary capital for non-federally-guaranteed education loans. But bankers sued to block the plan, claiming that access to insured deposits violated the company's charter.

Joint Venture

Four years ago, bankers were riled again when Sallie launched a joint venture with the College Board and New York-based Teahers Insurance and Annunity Association to offer "one-stop shopping" for college loans. Bankers claimed the plan would allow Sallie Mae to take the best loans and leave them with default-prone loans from trade schools and other nondegree institutions.

Sallie Mae dropped both efforts after opponents successfully argued that the agency's federal charter did not allow such activities.

Bankers are again suspicious after the agency and Chase Manhattan Bank last month announced and eight-month joint-venture that effectively has Sallie taking over all the functions of Chase's student loan business.

"About the only remnant of Chase will be its name on loans," said one New York banker familiar with the arrangement. "Sallie Mae will do everything else. You could call it de facto direct lending."

In Name Only

Under the deal, Sallie Mae will manage a dedicated marketing operation called Education Finance Center Inc., which will hire virtually everyone who now works in Chase's $850 million-a-year student loan operation. The arrangement allows Chase to continue to offer loans to its customers, but in name only.

Sallie Mae will exclusively purchase all the loans. Terms of the deal were not disclosed.

"It's the marketing and the processing that they are doing," a Chase spokesman said. "Chase is still making the loan."

Sallie Mae's Mr. Greene points out that Chase will stil have legal liability for the loan. Noting that it is not legal for his agency to make the loan, he adds pointedly: "We are not an originator of student loans."

Beyond the debate over whether Sallie Mae will enter direct lending, the Chase agreement shows that the future could hold for the agency. With a keen reputation for strong marketing and up-to-date technology, the company will surely benefit as many banks begin to decide whether to stay in the student loan business or exit it.

Bidding on Portfolios

Certainly, the loss of profit margin will drive some from the business altogether. For those banks, Sallie Mae is expected to aggressively bid to buy their portfolios. For those who want to be able to offer loans for fee income, but don't want the overhead, a Chase-style agreement is possible.

Because the Department of Education is getting into direct student loan lending "there are a number of banks who are looking at their business, and there are many who look at this as a time of opportunity," said Ms. Marshall. "The full impact on [profit] margins won't take place until mid-1995, and the greatest shakeout will happen then."

Sallie Mae began laying the groundwork long ago for the kind of technology that would lower its own cost of processing and servicing billions of dollars in student loans. In the last year, it has more than doubled, to 600, the number of companies that use it to provide services.

Even the phase-in of federal direct lending is not likely to put Sallie Mae out of business. The plan approved by Congress brings in the Department of Education over several years, and still leaves room for Sallie Mae in the secondary market.

Private-Sector Dynamos

Few believe that a government bureaucracy will be able to compete with aggressive private sector companies such as Citi-corp's Student Loan Corp. or The Money Store.

Regardless of how much lending the government directly controls, the student loan business is expected to continue its double-digit growth as eligibility is expanded to more middle-class families. Even if Sallie Mae does not increase the one-third of the secondary market it controls, the total size of the program could rise. The agency estimates that originations through 1998 could reach $125 billion, compared with about $70 billion over the previous five years.

But Sallie Mae is hedging against an uncertain future by looking for new opportunities. The agency is likely to continue expaning a university facilities and equipment financing program that last year provided $350 million in capital.

So far, the agency has cited only one new business it wants to move into: funding job retaining programs.

'Exit Fee' Discussed

Clearly, though, Sallie Mae's best hopes lie in relinquishing its federal charter. Whether Congress takes the unprecedented step of fully privatizing the agency may depend on the how deep its stockholders' pockets are.

Experts say that lawmakers are likely to demand an "exit fee" before it would allow the investor-owned company to fully privatize. Nobody knows how much Congress might demand or, more important, how much stockholders would be willing to pay for the agency's freedom.

"This is all uncharted water," said Smith Barney's Mr. Treadway, who points out that no GSE has ever sought to privatize. "I don't think shareholders will stand much of a fee."

Sallie Mae's Mr. Greene says no numbers have been discussed with federal officials, and he is vague on the issue of how much Congress might expect. Pointing out that legislation has already slashed its profit margins and left it in the Wall Street dog house, he adds wryly: "In one sense, we aleady feel like we've given."

Others say Congress may not want to lose control of Sallie Mae in case direct lending by the Department of Education flops. "People on capitol hill see Sallie as a government asset," said Dalls investment banker Robert Estrada, a former Bush White House aide who just completed a four-year stint on the agency's board. "Politically, there is less than a 50-50 chance that they'll get approval to privatize."

The matter is far from the Beltway's fast track. Treasury and Department of Education officials are expected to report to Congress as early as this month on whether they support Sallie Mae's privatization.

Even if it does happens, one analyst says it will be tough to repeat the profitable old days.

"What they had in the 1980s is a tough act to follow," said Gary Gordon, a financial services analyst at PaineWebber Inc.

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