Analysis: Student lending growth fuels M&A talk

By Archana Shankar

BANGALORE (BestGrowthStock) – The $160 billion U.S. student lending industry is set for more consolidation as big banks and others are drawn to the sector’s renewed growth and as cheap valuations throw up attractive targets.

Others already in the business, but with shrinking Federal Family Education Loan Program (FFELP) portfolios, may look to monetize assets and get out.

Although private student lending and fees from processing government loans to students are growing, lenders such as Sallie Mae (SLM.N: ), Nelnet (NNI.N: ) and First Marblehead Corp (FMD.N: ) still trade at relatively cheap levels.

“You could buy Sallie Mae at mid-to-high teens (dollars per share) and you’re still getting it at an attractive price,” said Keefe, Bruyette and Woods analyst Sameer Gokhale. “I have a $16 share price target and it’s trading at about $12.”

Any move on Sallie Mae at around $17 a share could value it at upwards of $8 billion.

Some deals already struck include First Marblehead’s near-$50 million buy of Tuition Management Systems, and Discover Financial Services’ (DFS.N: ) $600 million acquisition of Citigroup’s (C.N: ) Student Loan Corp’s (STU) (STU.N: ) private student loan portfolio.

As federal aid to students lags rising education costs, private lenders see a growth opportunity.

Private lending grew at around 30 percent a year until 2008, but slumped as the securitization market seized up and federal aid rose by a quarter in the 2010 academic year.

Student lenders lost a key source of revenue in July when the government scrapped its 45 year-old FFELP — a subsidized private sector student loan program — prompting companies to cut jobs and realign their business models.

A low competition/high growth potential scenario is bringing in new entrants such as credit unions and seeing the return of banks and state loan agencies, even as student loan defaults rise.

Around 3.4 million student borrowers started repaying loans in 2008, and more than 238,000 defaulted amid high unemployment rates, government data showed.

DISTRESSED PRICES

“We’re on the verge of seeing a lot more growth in the private loan market, so banks are looking to buy now as they can get assets at distressed prices,” FBR Capital Markets analyst Matt Snowling said.

Banks, struggling with slow loan growth, are likely buyers as they can find balance sheet growth in a high return asset class.

Bank of America Corp (BAC.N: ), which exited private student lending more than two years ago, may look to jump back in by buying a specialty lender, Snowling said. BofA failed to acquire Sallie Mae in 2007.

Deutsche Bank (DBKGn.DE: ) and some U.S. regional banks are also keen to raise their profile in the fast-growth private student lending market through acquisitions or partnerships, analysts said.

JP Morgan (JPM.N: ) and Wells Fargo (WFC.N: ) may look to buy private student loan portfolios, while Sallie Mae, which bought a $28 billion portfolio from STU, may look to bolster its asset base, they added.

But, with just a handful of student lenders controlling most of the private student lending market, buyers will have to move fast to secure the best assets.

“If you’re not among the first movers you may have to build them on their own, which will take many years,” said Mark Kantrowitz at FinAid.

Starting a business from scratch would involve setting up a distribution network and building underwriting capabilities. It can take years to build scale, said FBR’s Snowling.

Discover Financial said it expects to gain about 300,000 new customers from its STU deal, giving it the opportunity to sell students other financial products and services.

(NON)-ECONOMIES OF SCALE

Traditional banks and non-profit lenders, elbowed out of the federal student loan program, still have existing loan assets on their books, and may look to exit the industry.

“These loans will remain on their books for the next 10-15 years,” Snowling said. “You’d have to maintain an entire servicing operation to cater to a declining portfolio over a long time. So dis-economies of scale will kick in eventually.”

SunTrust Banks Inc (STI.N: ) and KeyCorp (KEY.N: ) are among those asking themselves whether to stay in the business, Snowling said.

“Another $300 billion of loans held by FFELP lenders is not eligible for sale to the Department of Education,” Snowling said.

Sallie Mae, with $150 billion in federal loan assets, and Nelnet, with $26 billion, are expected to buy FFELP portfolios.

CEO Albert Lord predicts Sallie Mae’s FFELP portfolios will generate significant cash flow and earnings.

“These loans are government guaranteed, the cash flows associated are highly predictable, both in terms of absolute dollars and timing,” he said.

(Reporting by Archana Shankar in Bangalore, Editing by Ian Geoghegan)

Analysis: Student lending growth fuels M&A talk