SLM Corp.: Is It Time to Enter a Growth Business With 'Sallie Mae' Shares?

| About: SLM Corporation (SLM)
Next year nearly 20 million students will be enrolled at college. With the average private and public annual tuition expected to be $37,000 and $16,100, respectively, a lot of families will be looking for additional funding sources. One company positioned to benefit is SLM Corp. (NYSE:SLM), also known as Sallie Mae, the largest private originator of student loans with a 33% market share.
SLM Corp. is no longer able to originate government student loans, known as FFELP loans, following the government’s decision last year to bring the lending in house. This has created both an overhang and opportunity in SLM shares as uncertainty over the company’s future has kept investors on the sidelines.
But, as we move further away from recession and beyond the shift in SLM’s business model to private loans only, shares are positioned to move higher. Especially given that demand for private loans is expanding once again.
SLM is the biggest of the private loan originators, with a $35.7 billion portfolio. In Q4, private loan origination was 8% higher year over year, the first year over year growth in two years. This portfolio is expected to grow by another $2.5 billion in loans this year, reflecting 10% loan growth from 2010. And, the private loan portfolio earned a solid net interest margin of 3.85% last year.
College enrollment is growing alongside the population and is expected to reach 22.4 million in 2019, according to SLM. And, the company estimates the funding gap private loans serve at $9 billion. Also, given parental belt-tightening, private loans have upside given parents are expected to contribute $189 billion annually to their children’s college education.
One of the biggest risks to lenders, including SLM, has been delinquency and default rates. Like other loans, student loan repayment trends have been improving alongside private sector job growth. Provisions for losses in its FFELP segment fell to $98 million in 2010 from $119 million in 2009. Provisions for private loans fell to $1.298 billion from $1.399 billion in 2009. Private loan charge offs fell to 5% last year from 6% in 2009, trending lower throughout the year. Delinquencies fell to 10.6% from 12.1% last year versus 2009.
At the same time, a tighter lending standard has driven the percentage of co-signed loans higher, improved the average FICO score and lowered non-traditional loan volume. And, unlocking securitization markets have provided improved lender funding costs too.
Despite the inability to originate FFELP loans, SLM continues to benefit from its significant legacy loan portfolio, totaling $148.6 billion. This year, that portfolio will generate $1.73 billion in revenue for the company. And, although those loans will roll off as they mature, the company still expects to generate $1 billion in revenue from them in 2017. The company will generate stable cash flow and net interest margins on the portfolio, particularly as it reduces costs alongside the loan run-off.
FFELP operating expenses fell to $736 million last year from $754 million in 2009, helping net interest margins expand to 93 basis points from 67 basis points in 2009. The business is so interesting: SLM wants to acquire additional FFELP portfolios from banks. In December, SLM bought $26 billion in FFELP loans, and gained 1.3 million new customers, from Citi’s The Student Loan Corporation, in an immediately accretive deal. The opportunity to add additional loans is significant given 30% of all FFELP loans sit in small players hands.
Outside of private loan origination and its legacy FFELP portfolio, the company is also looking to expand its management and services segment, which handles $235 billion in education loans and administers $35 billion in 529 plans.
Another compelling reason to own SLM is the likely reinstatement of dividends or buybacks later this year. The company believes it will be on stable enough ground in the back half of this year to recommend to its board instituting either or both – a move which will be welcomed given they were halted in 2007 due to the recession.
Overall, student loan debt remains a growth business. This year, student loan debt surpassed credit card debt for the first time. As costs continue to rise and students and parents continue to look for payment solutions, SLM shareholders will be rewarded.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SLM over the next 72 hours.

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