Circumstances beyond its control drove Sallie Mae into retail banking, but the venture, once a stopgap, is now the cornerstone of its survival strategy.

Sallie Mae, whose formal name is SLM Corp., recently began offering high-yield savings accounts and certificates of deposit through its branchless Utah-based bank unit. That gives the Reston, Va., company an additional source of funding for its student loans at a time when the capital markets are still struggling to bounce back. And it doesn't plan to stop there.

"It's a move out of necessity, to be honest," said Matthew Snowling, a managing director at FBR Capital Markets. "Step back and look at Sallie Mae's business model. Until very recently … it was entirely dependent on the securitization markets for funding. … This is an acknowledgement that they will have to come to rely on the bank more and more."

The disruptions in the credit markets may have worked in the company's favor, however. Sallie Mae says it has an opportunity to expand into a full-fledged retail bank.

"You can argue that we should have been in this business sooner," Kelly Christiano, the company's vice president of savings and rewards, said in a recent interview.

"Having retail as part of our funding strategy will be important, even if the securitization market becomes stronger," Christiano said. "We're building a customer franchise. We have lots of plans around bundling products, and we think we're in a unique position to do so. We see it as being an important part of our customer strategy."

Sallie Mae had been considering getting into retail banking ever since it established an industrial loan charter in Utah in 2005, Christiano said. The freezing of the capital markets just helped push those plans along a little bit faster.

Still, as the capital markets come back, Sallie Mae believes it is useful to have a retail banking arm.

"We have over 20 million consumers that do business with us today, and so we're really focused on that opportunity and looking at what other products in retail banking we should be bringing to market," Christiano said. "There is a lot more we can do."

Christiano would not specify what types of products might be next, but presumably they might include checking accounts and debit cards.

The student loan industry has undergone a transformation in the last few years. The shutdown in the capital markets hit lenders like Sallie Mae hard. But more recently, the Health Care and Education Reconciliation Act has changed the way student lenders do business. The legislation required that federally subsidized student loans be made directly by the federal government starting in July, leaving lenders to specialize only in private loans. (However, private lenders will still be able to service government-funded loans.)

Though this takes away a chunk of business from private lenders, analysts predict that demand for private loans could increase. As the price of education continues to rise, and caps on government loans are reached, students will need to look to additional funding sources to fill the gap, they said.

"It's one of the few areas which should have a reasonable amount of growth over the next few years," said Sameer Gokhale, a senior specialty finance analyst at KBW's Keefe, Bruyette & Woods.

Sensing the opportunity, other financial services companies have been expanding their student lending divisions.

In September, for example, Discover Financial Services agreed to buy Student Loan Corp. and acquire $4.2 billion of its private student loans, as well as $3.4 billion of its asset-backed securitization debt funding.

"I think one of the reasons for Discover's acquisition was the attractiveness of cross-selling opportunities," Gokhale said. "The idea is you make a student loan to a student and their family, [and] maybe later you can offer credit cards and mortgage loans."

Christiano acknowledged the cross-selling opportunities that a retail bank affords. She said starting with savings products made the most sense for Sallie Mae because its customer base was already familiar with the importance of saving.

"People are saving more at [this] point in time given the things going on in the economy," said Christiano, who was president of VIPdesk, a call center outsourcing company, before joining Sallie Mae in 2007. "We felt we should have more products to enable the customers we were already doing business with to save with us."

The company also had a ready-made rewards program that it could combine with the savings account. It bought the rewards-services startup Upromise Inc. in 2006 to help its customers save money for college expenses.

Sallie Mae did a soft launch of its high-yield savings account and CDs in February and began marketing them in May, primarily online.

Currently everything is done online; the company has no plans to open up retail branches, which, analysts said, is a strategy that can work so long as it can deliver strong customer service.

"They're not burdened with the high costs of retail bank branches; however, they do need to learn the banking business," said Craig Focardi, a senior research director for consumer lending at TowerGroup. "Bank savings products and customer needs are different from student loans, so they need to add the right people as well as technology resources in order to execute on a diversification strategy."

Christiano said an online bank appeals to its target demographic of college-age individuals and young parents.

"Being a direct bank is easier today than 10 years ago," she said, "and the demographics today makes it a good channel."

As of June 30, Sallie Mae bank had $5.9 billion of deposits.

Whether Sallie Mae's strategy works for the long haul, or simply buys it some time, analysts aren't sure. Sallie Mae could find itself in a jam if demand for loans picks up faster than the capital markets come back. Analysts noted that Sallie Mae can depend on deposits for funding only for so long, since the life of its student loan assets (six to seven years) is longer than the life of its longest-term CD (five years).

Some say the company's diversification efforts make it more attractive to a potential buyer down the line, while others say if it was bought out, the acquisition would likely be by a large bank that already has a retail presence and would be more interested in its student loan assets. Either way, it's possible Sallie Mae's future contains a sale.

"If you look at bank balance sheets, they are shrinking, and this in the one area that is expected to grow at a nice clip," Gokhale said.

"It will be hard for Sallie Mae to continue on its own," Snowling said. "They were inches from being bought by Bank of America [Corp.] and JPMorgan [Chase]," he said, referring to a bid in late 2007 from a group of investors led by the private-equity firm J.C. Flowers & Co. that eventually fell through. "There was a reason they were looking at Sallie then. They eventually could be looking at it again."


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