Sallie Mae Tops Estimates

| About: SLM Corporation (SLM)

SLM Corp. (NYSE:SLM), better known as Sallie Mae, reported fourth quarter 2010 core earnings of $401 million or 75 cents per share, ahead of the Zacks Consensus Estimate of 72 cents. The results compare favorably with prior-year quarter’s core earnings of $268 million or 44 cents per share. Favorable results were primarily driven by decrease in loan loss provisions and gains from repurchasing debt. During the quarter, the company repurchased $1.3 billion of debt with realized gains of $118 million.

For full-year 2010, core earnings increased to $1.03 billion or $1.92 per share from $807 million or $1.40 per share in 2009 and were ahead of the Zacks Consensus Estimate of $1.84 per share. The increase was driven by improved federal student loan margins and decreased provisions for loan losses.

On a GAAP basis, fourth quarter 2010 net income came in at $447 million or 84 cents per share, up from net income of $309 million or 52 cents per share in the comparable period last year. For full-year 2010, GAAP net income increased to $530 million or 94 cents per share from $324 million or 38 cents reported a year ago.

Quarter in Detail
Sallie Mae stopped originating new federally guaranteed student loans after June 30 to comply with the legislation forbidding private sector companies from such loans. As a result, the company modified its operating segments as Consumer Lending, Business Services and Federally Guaranteed Loans.

Consumer Lending: The segment generated core earnings of $24 million in the fourth quarter, compared with $20 million in the year-ago quarter. Private education loans originated increased to $413 million from $381 million in the year-ago quarter.

With the economy registering improvements, though at a sluggish pace, the company had $3.5 billion more private education loans in repayment compared to a year earlier. Private loan delinquencies also declined to 10.6% in the quarter from 12.1% in the comparable prior-year period. Even charge-offs decreased to 4.8% in the reported quarter from 5.1% in the prior-year period.

Business Services: The segment reported core earnings of $118 million, down from $136 million in the year-ago quarter. Earnings in this segment typically include fees from servicing, collections and college savings businesses.

Sallie Mae currently services 3.3 million accounts under the servicing contract with the U.S. Department of Education (NYSE:ED). In 2010, the company added five new states to which it provides administrative services and currently administers $34.5 billion in 529 college savings plans for 16 states.

Federal Family Education Loan Program: The business segment generated core earnings of $289 million in the reported quarter, up from $246 million in the year-ago quarter. The difference was primarily driven by an unstable CP-LIBOR spread in 2009. During the quarter, Sallie Mae sold $20.4 billion of federal loans originated under the ED loan participation program recognizing a $321 million gain.

Sallie Mae’s core operating expenses excluding restructuring, related asset impairments and fees connected to the recent Student Loan Corp. federal student loan acquisition were $289 million in the reported quarter, compared with $264 million in the year-ago quarter. As expected, the year-over-year increase stemmed from investments made in consumer lending and loan servicing businesses.

Business Update
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. (NYSE:C) subsidiary. The acquisition expands Sallie Mae’s customer base, by approximately 1.3 million, and should benefit future earnings.

Our Take
We believe that Sallie Mae’s leading position in the student lending market, restructuring initiatives and an efficient cost structure would provide it with an edge over its peers. We expect the company to benefit from the servicing contract. Cash flows from its business activities are also expected to be decent.

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. (NYSE:NNI) has to undergo significant changes as their traditional role requires significant modification. This remains a major concern.

However, credit improvement, strategic acquisition and overall economic improvement, though at a tardy pace, should support Sallie Mae’s future earnings.

Sallie Mae shares retain a Zacks #3 Rank, which translates into a short-term Hold recommendation. We have a long-term Neutral recommendation on the stock.