Sallie Mae Sell Rating Maintained

SLM Corp. (SLM - Analyst Report) reported 1Q09 GAAP net loss of $21 million or $0.10 per diluted share, compared to $216 million or $0.52 per diluted share in the prior quarter. The primary reason for the lower-than-expected results was the decline in the net interest income due to the wide spread between CP rate (index in which SLM’s federal student loan assets are based) and LIBOR (principal index in which SLM’s liabilities are based).

Credit metrics worsened during the reported quarter. Net charge-offs as a percentage of average managed private education loans (PELs) in repayment increased 70 bps sequentially and delinquencies as a percentage of managed PELs in repayment increased 320 bps sequentially.

Higher funding costs also added to the negative results. However, we expect funding costs to come down slightly once the federally sponsored programs (TALF and Conduit Facility) gather momentum.

One of the items in President Obama's budget proposals for fiscal 2010 -- the elimination of private lenders from the student-loan market and the shift of the entire system to direct governmental loans -- is a major concern for SLM at this point. Governmental support was the main incentive for private lenders such as SLM to take part in the market because high levels of default absorb the majority of earnings that lenders derive from student loans.

The budget proposal, if implemented, would end the FFELP lending program effective July 1, 2010. Consequently, SLM’s traditional role would change to one of originator, and its loan portfolio would become heavily weighted toward higher-risk private student loans.

On May 14, 2009, Moody's Investors Service downgraded the long- and short-term ratings of SLM amid concerns of its liquidity, funding position and future earnings, which may be negatively affected by the budget proposals. Moody’s slashed its rating on the company's senior unsecured debt into junk status.

We are maintaining our Sell recommendation on SLM.