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Sallie Mae Upped to Outperform

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We are upgrading our recommendation on SLM Corp. (SLM - Free Report) to Outperform from Neutral following a detailed analysis of the company’s second quarter 2011 earnings results.

SLM Corp., commonly known as Sallie Mae, reported second quarter core earnings of $260 million or 48 cents per share, beating the Zacks Consensus Estimate of 42 cents. The results also compared favorably with the prior-year core earnings of $211 million or 39 cents per share.

Favorable results at Sallie Mae were primarily driven by an increase in student loan originations, improved credit quality with declines in student loan delinquencies and operating expenses. The positives were partially offset by lower debt repurchase gains.

However, on a GAAP basis, Sallie Mae reported second quarter 2011 net loss of $6 million or 2 cents per share, down from a net income of $338 million or 63 cents per share in the comparable quarter last year.  

The loss stemmed from a pre-tax $414 million unrealized, mark-to-market loss on certain derivative contracts recognized in the reported quarter. Notably, the year-ago quarter’s results included a $211 million unrealized, mark-to-market gain.

For full-year 2011, Sallie Mae management expects to generate core earnings of $1.80 per share and anticipates private education loan originations of $2.5 billion. Reduction of expenses is the company’s primary focus. Moreover, the company expects to achieve its quarterly operating expense target of $250 million by fourth-quarter 2011.

We believe that Sallie Mae’s leading position in the student lending market, its cost curtailment initiatives and the federal student loan assets acquisition augur well. Sallie Mae successfully accomplished the acquisition of $26 billion in securitized federal student loan assets from The Student Loan Corporation, a Citigroup Inc. (C - Free Report) subsidiary, in December 2010. The acquisition expanded Sallie Mae’s customer base by approximately 1.3 million and promises earnings accretion ahead.

Pausing new federal student loan origination to comply with the legislation would affect revenue generation at student lenders like Sallie Mae and Nelnet Inc. . However, we believe that its diversifying efforts coupled with an economic recovery, though at a sluggish pace, would bolster its earnings by expanding its private education loan business and reducing its loan loss provision expenses. Capital deployment efforts also give a fillip to investors’ confidence in the stock.

Additionally, Sallie Mae shares currently retain its Zacks #1 Rank, which translates into a short-term ‘Strong Buy’ rating.

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