Sallie Mae Surpasses Estimates

SLM Corporation (SLM - Analyst Report) substantially topped expectations with adjusted profits of 32 cents per share. The second-quarter results were aided by 325 million gains on debt repurchases, offset partially by $105 million of expenses related to the ongoing dislocation in the commercial paper market and a 109.1% increase in provisions for loan losses.

On a GAAP basis, SLM reported a net loss of $0.32 per share, compared to a net loss of $0.10 per share in the prior quarter and a net income of $0.50 per share in the prior-year quarter. The adjusted results include after-tax restructuring expenses of $2.8 million and other reorganization-related asset impairments of $0.2 million.

The company generated experienced 76.0% year-over-year increase in FFELP internal brand originations. However, FFELP Lender Partner originations declined 30.0% over the prior-year quarter. Private Education Loan (PEL) originations declined 56.4% year-over-year to $372 million in the reported quarter. The decrease was a result of the tightening of underwriting standards, the elimination of non-traditional private loan originations and withdrawal from certain markets.

SLM provided $362 million for managed private loan losses. This was due in part to growth in loans in repayment status and higher delinquencies resulting from a continued weakening in the overall economy and a managed reduction of loans in forbearance status. Average managed student loans were up 1.8% sequentially and 9.6% year-over-year to $188.5 million.

Credit metrics were mixed during the quarter, with annualized net charge-offs at 6.7% of average managed PELs in repayment (up 270 bps sequentially) while delinquencies decreased 70 bps sequentially to 12.7% of managed PELs in repayment.

Core ROA for the quarter was 0.34%, compared to 0.03% in the prior quarter and 0.34% in the prior-year quarter. However, on a GAAP basis, ROA deteriorated to negative 0.30% from negative 0.05% in the prior quarter and positive 0.74% in the prior-year quarter.

Managed net interest income (on a core basis) for the quarter, which represents 46.5% of net revenue, increased 6.5% sequentially but decreased 22.2% on a year-over-year basis to $456.9 million.

SLM’s core cash non-interest income for the quarter increased 120.1% sequentially and 116.9% year-over-year to $525.8 million, with positive contribution from the entire source. In all, core cash net revenue increased 47.1% sequentially and 18.5% year-over-year to $982.8 million.

Core cash operating expenses for the quarter increased 4.7% sequentially but decreased 9.8% year-over-year to $305.4 million.

In response to the impact of the College Cost Reduction and Access Act of 2007 and current capital market challenges, SLM continues to restructure its business. As part of its cost reduction efforts, the company recognized $5 million and $4 million restructuring expenses during the first and second quarters of 2009, respectively. Restructuring expenses from the fourth quarter of 2007 through the second quarter of 2009 totaled $115 million.

Most of these restructuring expenses was severance cost related to the completed and planned elimination of approximately 2,800 positions, or approximately 25% of the workforce. The company estimates an additional $7 million of restructuring expenses by the end of 2009.

As part of its objectives, SLM intends to grow its assets at a higher pace than in the last year. The company also aims to reduce its borrowing costs during the remainder of 2009 because FFELP is a very narrow-margin product requiring collateral levels that are too high.

Though 2009 is expected to be the peak charge-off period, SLM wants to exit the year with a lower charge-off than in the prior year. We think that SLM will get some relief with respect to its funding challenge as a result of two federally sponsored programs, the Department of Education Conduit Facility and the Federal Reserve's Term Asset-backed Liquidity Facility (TALF).

Though we think that SLM’s scale and efficiency will definitely give it an edge over its peers - Nelnet (NNI - Analyst Report) and Student Loan Corp. (STU) - to secure market share, there will remain some major concerns for SLM at this point. The elimination of private lenders from the student-loan market and the shift of the entire system to direct governmental loans as proposed by the Obama administration will be a thorn in SLM’s side. Further, the company was recently downgraded by Moody’s based on concerns relating to its earnings and cash flow generation.