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SLM Corporation (SLM) or commonly know as Sallie Mae, reported third quarter core earnings of $164 million or 26 cents per share. Results were well ahead of the Zacks Consensus Estimate of 8 cents per share. The company had earned 19 cents in the year-ago period.

Results reflected improvements in the credit market and an increase in loan originations. However, loan loss provisions remain high.

Quarterly results included a gain of $74 million on the repurchase of debt and a $55 million accounting adjustment to reflect slower loan prepayments.

Sallie Mae posted a net income attributable to common stock of $116.5 million, or 25 cents per share, compared with a loss of $186 million, or 40 cents, in the year-ago period. Core earnings return on assets was 0.31%, up 6 basis points (bps) year-over-year.

Sallie Mae originated $6.9 billion in federal student loans in the reported quarter. This represents a 25% increase from the prior-year period. The company wants to service these loans which are eligible for the U.S. Department of Education’s purchase program.

However, the origination of private education loans (PELs) decreased significantly during the quarter. Sallie Mae originated $893 million in PELs compared to $2.1 billion in the year-ago quarter. Results reflected conservative underwriting approach and a decrease in loan demand, reflecting recession.

Net interest income (on a core basis) for the quarter was $689.6 million, down 3.2% year-over-year. Credit metrics weakened during the reported quarter. Provision for private education loan losses was $413 million, up from the second quarter's $362 million, while charge-offs rose to $443 million from $355 million in the previous quarter.

Annualized net charge-offs were 8.1% of average managed PELs in repayment (up 140 bps sequentially) while delinquencies increased 40 bps sequentially to 10.0% of managed PELs in repayment. Though management expects loan charge-offs to decrease from the current quarter, they are still expected to remain at historic highs.

Core fee income including the debt repurchase gain was $331 million. Results were well ahead of the prior-year period’s income of $64 million. However, we note that the prior-year quarter’s results included $242 million impairment in the company’s purchased-paper line of business.

The company reported operating expenses of $309 million, a 2.5% decrease from the prior-year quarter’s expense of $317 million.

Sallie Mae also remains focused on bolstering its capital levels. This included the completion of $2.8 billion in private education loan securitizations, reducing the asset-backed commercial paper or ABCP outstanding facilities to $9.4 billion from $12.5 billion at the end of the previous quarter, repurchasing of $1.4 billion of unsecured debt which generated a gain of $74 million and funding $3.2 billion through the Straight A conduit program.

The company is also restructuring its business in response to recent legislative moves and current capital market challenges. As part of the cost reduction efforts, Sallie Mae recognized $3.6 million of expenses in the quarter.

However, the House of Representatives has recently approved a bill that would effectively eliminate the role of private lenders in the student loan market and establish the government as the sole lender of student loans under a program run by the US Education Department.

If enacted, the bill would put an end to the Federal Family Education Loan Program and severely impact banks, particularly student lenders such as Sallie Mae. Besides Sallie Mae, other companies who could be at risk under the new legislation are Student Loan Corp. (STU), Nelnet Inc. (NNI), ITT Educational Services (ESI), SunTrust Banks (STI) and Corinthian Colleges Inc. (COCO).

Nevetheless, we expect that if the bill is enacted, Sallie Mae will be a major participant in the Department of Education’s servicing contract, under which it will service and collect government guaranteed loans. Pending further developments, we recommend to Hold the shares of Sallie Mae.

Source: Sallie Mae Q3: Ahead of Estimates