For years, the bears’ big complaint about First Marblehead (NYSE:FMD) has been that that the company doesn’t contribute anything of material value the student-loan origination process. It doesn’t lend (the bank partners do); it doesn’t service (third-party servicers do); it doesn’t guarantee (TERI does), and on and on. Eventually, therefore, Marblehead will be disintermediated by its partners and its business will disappear. Simple! To back up this line of thinking, critics pointed in instructive contrast to Sallie Mae (NYSE:SLM), which originates a substantial portion of its business directly, without involvement of partners, and thus has its own solid, standalone franchise.
I happen to think that objection is nonsense, of course. Marblehead has considerable underwriting and product development expertise its competitors and partners can’t duplicate. If the company weren’t part of the lending process, its partners wouldn’t be able to originate student loans nearly as profitably as they do. (If you want to know why, click here and here.)
Anyway, it’s now come to the point where the bears aren’t just wrong on this point as a matter of judgment. They’re wrong as a matter of fact. In 2006, the portion of loans Sallie Mae originated directly, via its internal brand, came to just 38% of total originations. But Marblehead now originates on its own, too. In fiscal 2007 (which ended in June) the portion of loans the company originated directly, via its own brands came to 12%--and that number is growing very, very quickly. In the fiscal fourth quarter, for example, fully 20% of Marblehead-facilitated originations came via its in-house brands. My guess is that in-house originations will come in at close to 20% of the total again this quarter. That implies roughly $400 million in in-house originations for the quarter, nearly equally to Marbleheads's in-house originations for all of fiscal 2007.
(Marblehead's in-house efforts are a win-win for it and its partners by the way. The business is profitable in its own right and, more important, is a useful testing ground in which the company can come up with winning strategies it can then share with its partners.)
My bottom line: the growth of Marblehead’s in-house brands means that the company’s franchise value is increasing rapidly. Sallie, by contrast, is about to be saddled with $16 billion of debt and is suddenly in the midst of a legal and regulatory environment not nearly as benign as it was not so long ago.
Who’s got the better franchise now?
Tom Brown is head of BankStocks.com.