Sallie Mae Student Loan Sale Makes Accounting Overhaul

Student loan giant SLM Corp., known as Sallie Mae, warned investors last year that the new accounting rules for bad loans would skew its balance sheet so much that it would have to resort to unofficial action to pass his financial health.

The company reversed course on Thursday, saying it would introduce official accounting measures, after all, when the current expected credit losses (CECL) accounting standard will live this year.

It is able to do this by selling $ 3 billion in loans and using the proceeds to buy back $ 600 million of its stock, which means more income to be distributed among fewer shareholders.

The company’s loan loss reserves are still tripling under CECL, but the stock buyback is expected to improve its share price, bringing Wall Street’s happiness. When investors are satisfied, there is less incentive for companies to use non-GAAP measures or measures that do not conform to US generally accepted accounting principles.

“It masks the impact of CECL,” said Sanjay Sakhrani, Managing Director of Keefe Bruyette & Woods, Inc.

Company executives said the accounting change was not the motivation behind the sale.

“The sale of the loans had nothing to do with CECL,” CEO Raymond Quinlan told investors during the company’s earnings call. “There was no reason to take these assets off the books. They were just profitable.

Free up capital

But the offloading of loans helps to mitigate the impact of the accounting change. This is in part because building loan reserves can affect the capital held by a company to meet regulatory requirements. Less money tied up in capital gives the company the freedom to buy back shares.

“Without selling these loans and releasing the capital from these reserves, they could not buy back shares,” Sakhrani said. “And so this is a way to continue to be relevant in the market by making loans like you always have and continuing to replenish the capital that is depleted because of CECL.”

This decision also eliminates the need to use non-GAAP measures. Businesses typically use unofficial accounting metrics when their official accounting numbers don’t look good. Adherence to official GAAP also keeps the company in good graces with the Securities and Exchange Commission, which warned last year against companies using non-GAAP numbers when new loan loss accounting takes effect. .

“Obviously the SEC wants everyone to be GAAP and we will be,” Quinlan said. “But we will strive to give our investors all the information they need to calculate what we believe to be the continued profitability of the business. But we are bound by the rules to kind of publicize and publish GAAP. ”

“Disproportionate impact”

The Financial Accounting Standards Board’s post-financial crisis accounting overhaul aims to get banks and other businesses to think about and highlight losses before loans deteriorate. The accounting standard requires companies to take into account past experience, assess current conditions and look to the foreseeable future to calculate losses, and then build up reserves to cover them. The old rules forced businesses to wait for customers to miss their payments.

“Student loans are disproportionately affected by CECL,” said Paul Noring, managing director of the Berkeley Research Group.

This is because student loans can last for decades. The longer the loan, the more likely it is that problems will arise. But while loans like home mortgages also last for years, student loans are a more uncertain industry. College students take out loans for tuition fees before they start classes, and certainly well before they land a job to pay them off.

Now, student lenders must take all of this uncertainty into account when calculating the reserves they need to set aside to cover losses.

For Sallie Mae, the impact is important. The company plans to triple its reserves under CECL. The company has revealed that the loan loss reserve will drop from $ 400 million to $ 1.6 billion when it releases its first quarter results in the spring. When the sale of the loan is completed, the company may reverse part of this reserve accumulation in the quarter in which it occurs. Assuming it successfully sells these loans, the company plans to increase its reserves quarter-over-quarter from $ 285 million to $ 305 million.

“And so we expect CECL to be non-volatile,” Quinlan said.

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