Sallie Mae Downgraded to Neutral

We have downgraded our recommendation on SLM Corp. (SLM - Analyst Report), better known as Sallie Mae, to Neutral from Outperform in anticipation of slower credit quality improvement due to this sluggish economic recovery.

In January, Sallie Mae reported fourth quarter 2010 core earnings of 75 cents per share, marginally ahead of the Zacks Consensus Estimate of 72 cents. The results also compare favorably with the prior-year quarter’s core earnings of 44 cents per share.

Favorable results were primarily driven by a decrease in loan loss provisions and gains from repurchasing debt. During the reported quarter, the company repurchased $1.3 billion of debt with realized gains of $118 million.

The company's credit quality has deteriorated thanks to the economic weakness. Over the last several quarters, Sallie Mae has experienced higher charge-offs and the loan loss provisions have remained elevated as such. The company faces full credit risk for its private student loans and some credit risk for its existing federally guaranteed student loans. Though we expect credit quality to improve in the forthcoming quarters, we believe that robust progress would still be elusive given the slow economic recovery.

However, given the elimination of the federally guaranteed student loan origination business last July following the passage of Student Loan Reform Act, the business model of companies such as Sallie Mae and Nelnet Inc. (NNI - Analyst Report) have to undergo significant changes as their traditional role requires significant modification. This remains a major concern.

On the flip side, Sallie Mae suspended its dividend and shares repurchase programs in April 2007 and have not reinstated the programs since then. However, the company now believes that its cash flow and capital positions have strengthened sufficiently, and therefore by the second half of 2011, the company would be able to recommend to its board of directors for either reinstating a dividend, repurchasing shares, or doing a combination of both. Such shareholder-friendly efforts on the company’s part would boost investors’ confidence in the stock.

On December 31, 2010, Sallie Mae successfully accomplished the acquisition of $26 billion in securitized federal student loan assets from The Student Loan Corporation, a Citigroup Inc. (C - Analyst Report) subsidiary. The acquisition expands Sallie Mae’s customer base, by about 1.3 million, and should support its future earnings.

Sallie Mae currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.

Read the full analyst report on SLM

Read the full analyst report on NNI

Read the full analyst report on C