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Last week, Standard & Poor's (S&P) Ratings Services downgraded its outlook on SLM Corporation (SLM - Analyst Report) – also known as Sallie Mae – from ‘Stable’ to ‘Negative’. However, the rating agency affirmed its long-term issuer credit rating of ‘BBB-.’

Reasons for the Downgrade
 
The rating agency stated that the downgrade was driven by the company’s sale of interest in bonds supported by government-backed student loans, which resulted in reservations regarding the probability of future reduction in cash flows from the FFELP portfolio.
 
Earlier last week, Sallie Mae declared that it has sold its remaining interest in SLM Student Loan Trust 2007-4 securitization to a third party. This was partially due to the legislation passed by the House and the U.S. Senate in Mar 2012, terminating the Federal Family Education Loan Program (FFELP) that provided federal subsidies to private lenders.
 
However, under the existing contract, Sallie Mae will continue servicing the student loans in the trust. The sale will result in the removal of student loans of $3.8 billion and associated liabilities of $3.7 billion from the company’s balance sheet in 2013.
 
Even though the sale constituted a modest fraction of Sallie Mae’s assets, the rating agency believes that it symbolized an alteration in the company's approach associated with the FFELP portfolio. Previously, S&P anticipated that the lender would allow the FFELP portfolio to steadily run off instead of selling it.
 
According to management, the company has planned further selling of its asset-backed securities holdings supported by loans originated under the Federal Family Education Loan Program (FFELP). This step reflects the company’s shift of focus from FFELP loans to its private student loan business.
 
S&P further commented that the residual interests offered Sallie Mae with opportunities to diversify and expand its various segments. These include its private education lending segment as well as the servicing business, which are key growth drivers to mitigate the negative effect of the waning FFELP portfolio.
 
Our Viewpoint
 
The rating revisions play a major role in preserving investors’ confidence in the stock and help boost its creditworthiness in the market. Though Sallie Mae is working on addressing such issues, further rating downgrades could take place due to pressure on future cash flows. 
 
Additionally, suspension of the new federal student loan origination will continue to impact revenue generation capabilities of Sallie Mae. However, we believe that the company’s efforts to expand its private education loan business and reduce its loan loss provision expenses would bolster its earnings.
 
Further, the company’s leading position in the student lending market and diversifying efforts would help it navigate the current regulations and sluggish macro environment.
 
Sallie Mae retains a Zacks Rank #3 (Hold). Financial firms that are performing well include BankUnited, Inc. (BKU - Analyst Report), Fifth Third Bancorp (FITB - Analyst Report) and Regions Financial Corp. (RF - Analyst Report). BankUnited carries a Zacks Rank #1 (Strong Buy) and the other two hold a Zacks Rank #2 (Buy).

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