- JP Morgan notes they believe the provisions pertaining to the student loan industry that were included in the Fiscal 2008 budget proposed by the Bush Administration on Monday would place a significant drag on ROE and EPS growth at SLM. However, the firm believes it is still too early to determine if the budget will be passed in its current form and are therefore maintaining Neutral rating.
They believe the proposal as stated could turn SLM's FFELP business into a breakeven business if the 50bp reduction is applied to all FFELP loan originations without other corresponding changes by Sallie to boost revenues. The reduced profitability could be partly offset by lower borrower benefits or higher fees passed on to borrowers, but the FFELP program will need to remain competitive with the Direct Lending program.
Firm would expect EPS growth to fall to a low double-digit rate for the next several years if the proposals are passed as presented. 2008 EPS could be pressured by over $0.30 if the 50bp reduction affects all FFELP loans and if SLM needs to take a charge to increase its loan loss reserve with the lower principal guarantee.
Perhaps the biggest surprise with the student loan cuts was that they were included in the budget at all. The market expected the student loan industry to come under attack from the Democrats when they gained control last November because of their history as proponents of the competing direct lending program. However, it was widely expected that the Dems would have trouble getting a tough bill out of the Senate because of a lack of a filibuster proof majority, which is essentially the issue that killed a housing GSE bill in the previous Congress. The fact that these proposals come from a Republican President may signal that the FFELP lenders cannot count on help from the Republicans.
JPM notes they believe the current budget proposal may be a back door way for Bush to generate more interest in the Direct Lending program by reducing the attractiveness of the FFELP program for lenders.
- Keefe, Bruyette notes the hares of Sallie Mae and Nelnet (NNI) closed down 8.8% and 9.6%, respectively following this news as the proposed reduction in the lender yield was 50 bps compared to the 10 bps reduction investors expected from HR5. In firm's view, investor concern and the panic over the proposal is understandable but they believe the shares still seem undervalued.
Yesterday's release is the first step of a long budget process. The next step, which they believe will occur in March, is for Congress to pass a non-binding budget resolution which instructs individual committees on how to handle budget related items. The congressional committees will then consider legislation that impacts the federal budget. Each chamber of Congress will probably try to complete its own budget bill in the late spring or early summer and then try to pass a compromise budget bill in the summer or September. Firm thinks that sometime in March or April, the student loan debate should become clearer and investors should have a better idea of which way Congress will go. However, in KBW's view, yesterday's release is going to be popular with Democrats and will leave Republicans in a political corner from which they will have a difficult time opposing the Administration's plan.
Firm estimates that the President's proposal could decrease Sallie Mae's 2008 EPS by $0.28 and reduce the company's valuation by $13 assuming the company does not lower borrower benefits to offset the impact of the proposal. If Sallie Mae chooses to reduce borrower benefits to help partially offset the impact of the proposal, they estimate that it would reduce 2008 EPS by $0.15 and reduce the valuation by only $8 per share. If Sallie Mae eliminates borrower benefits completely, they estimate that it would only reduce valuation estimate by $5.
They continue to believe that proposals such as HR5 and the White House's budget proposal will force smaller lenders to exit the market and put their portfolios up for sale. The larger survivors could actually benefit by purchasing these portfolios in fire sales.
Firm is are lowering their year end 2007 price target for Sallie Mae to $52 from $60 assuming that the 2008 budget is adopted as proposed and that Sallie Mae chooses to partially reduce borrower benefits. However, they are maintaining EPS estimates, until the budget is finalized. Firm is maintaining Outperform rating on Sallie Mae because they believe the company's potential as a takeover candidate limits significant further downside to the shares.
Notablecalls: Looks like there may be some more selling pressure in SLM and related names this AM. Prudential and Lehman took their ratings down yesterday afternoon. Suspect there will be couple of more downgrades. Not actionable but 'good to know' category.