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We have upgraded our recommendation on SLM Corp. (SLM), better known as Sallie Mae, to Outperform from Neutral. The decision is based on Sallie Mae’s fourth quarter 2010 core earnings, which outpaced the Zacks Consensus Estimate, primarily attributable to the decrease in loan loss provisions and gains from repurchasing debt.

In January, Sallie Mae reported fourth quarter 2010 core earnings of 75 cents per share, marginally ahead of the Zacks Consensus Estimate of 72 cents. The results compare favorably with the prior-year quarter’s core earnings of 44 cents per share. During the quarter, the company repurchased $1.3 billion of debt with realized gains of $118 million.

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. (C) subsidiary. The acquisition expands Sallie Mae’s customer base by about 1.3 million, and should support its future earnings.

Sallie Mae had suspended its dividend and shares repurchase programs in April 2007 and has not reinstated the programs since then. However, the company now believes that its cash flow and capital positions have strengthened sufficiently, and therefore by the second half of 2011, the company would be able to recommend to its board of directors either reinstating the dividend, repurchasing shares, or a combination of both. Such shareholder-friendly efforts on the company’s part would boost investors’ confidence in the stock.

The rating outlook on 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 coupled with a recovery in the economy over the next two years. S&P also affirmed the long-term credit rating for Sallie Mae at BBB-.

On the other side, the economic weakness has resulted in a deterioration of the company’s credit quality. Over the last several quarters, Sallie Mae has experienced higher charge-offs and loan loss provisions have remained elevated as such.

The company faces full credit risk for its private student loans and some credit risk for its existing federally guaranteed student loans. Though we expect credit quality to improve in the forthcoming quarters, we believe that robust progress would still be elusive given the sluggish economic recovery.

However, given the elimination of the federally guaranteed student loan origination business last July, following the passage of the Student Loan Reform Act, the business model of companies such as Sallie Mae and Nelnet Inc. (NNI) has to undergo significant changes as their traditional role requires significant changes. This remains a major concern.

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

Sallie Mae currently retains a Zacks #2 Rank, which translates into a short-term Buy rating.

Source: Sallie Mae Weighs Investor-Friendly Moves