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The rating outlook on SLM Corporation (SLM), which is popularly known as Sallie Mae, has recently been upgraded to Stable from Negative by Standard & Poor's (S&P) Ratings Services. The upgrade reflects the rating agency’s expectation of an improvement in the quality of its private loans portfolio over the next two years with a recovery in the economy. The long-term credit rating of BBB- for Sallie Mae has also been affirmed by S&P.

By the end of next year, the rating agency expects a 20% or more decline in loan charge-offs. Substantial reduction in charge-offs in its "nontraditional" loans, higher-rate loans for borrowers with impair credit records, is also predicted by the agency. The company had stopped originating such loans in January 2008. Additionally, stringent standards for credit extension coupled with rigid policies for collecting loan repayments from borrowers should also improve the loan portfolio.

In January, Sallie Mae reported fourth quarter 2010 core earnings of $401 million or 75 cents per share, which were 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 attributable to a 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.

Sallie Mae successfully accomplished the acquisition of $26 billion in securitized federal student loan assets from The Student Loan Corporation, a Citigroup Inc. (C) subsidiary in December 2010. The acquisition expands Sallie Mae’s customer base by approximately 1.3 million and promises earnings accretion ahead.

Our Take

We believe that Sallie Mae’s leading position in the student lending market, restructuring initiatives and an efficient cost structure would give it a competitive advantage. The company is anticipated to benefit from the servicing contract with the U.S. Department of Education while cash flows from its business activities are also expected to be decent.

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) needs substantial change as their traditional role requires significant modification. This remains a concern.

However, credit improvement, strategic acquisition and overall economic improvement should support Sallie Mae’s future earnings.

Sallie Mae shares retain a Zacks #1 Rank, which translates into a short-term Strong Buy recommendation.

Source: Stable Outlook for Sallie Mae