We are downgrading our recommendation on
), better known as Sallie Mae, to Neutral from Outperform based on
a tepid economic recovery and the impact of the legislative changes
on its business.
First Quarter Results
Aided by a fall in loan loss provisions and decrease in
expenses, Sallie Mae's first-quarter 2012 core earnings came in at
$284 million or 55 cents per share, beating the Zacks Consensus
Estimate of 52 cents. Results also compared favorably with the
prior-year quarter's core earnings of $260 million or 48 cents per
share. However, the company experienced a decline in net interest
income and reductions in debt repurchase gains.
On a GAAP basis, Sallie Mae's first-quarter 2012 net income came
in at $112 million or 21 cents per share, down from $175 million or
32 cents reported in the comparable quarter last year. Notably, in
the reported quarter, Sallie Mae experienced a $131 million
increase in unrealized "mark-to-market" losses on derivative
contracts compared with the year-ago period.
Sallie Mae's Consumer Lending segment's core earnings were $81
million in the reported quarter, substantially up from $44 million
in the year-ago quarter. Reduced loan loss provision aided the
upswing. Moreover, its Business Services segment reported core
earnings of $139 million, up 5% from the year-ago quarter. The
company experienced a growth in servicing revenue in the reported
quarter from the Department of Education loan servicing
However, the Federally Guaranteed Student Loans (FFELP) business
segment generated core earnings of $82 million in the reported
quarter, down 25% from $109 million in the year-ago quarter. The
reduction stemmed from lower net interest income that resulted from
the fall in balances of the FFELP loan portfolio as well as higher
Sallie Mae has reiterated its guidance for 2012. For the full
year, management expects to generate core earnings of $2.00 per
share and anticipates private education loan originations of $3.2
Sallie Mae has a leading position in the student lending market.
However, in order to comply with the legislation, the company along
with other student lenders such as
) has stopped originating new federal student loans. To respond to
such changes, the company is making efforts to diversify its
Though such efforts are encouraging, we believe it would take
some more time for the company to reap the benefits of a transition
to its business model. Moreover, going forward, we believe that
with the run-off of its FFELP loan portfolio, its interest income
would be under pressure.
However, dividend hikes and increases in share buyback
authorization give a boost to investors' confidence. And despite
challenges, we anticipate that the company's cost containment
efforts would help it navigate through the current cycle.
Though the legislative actions challenged the company's business
model, we expect Sallie Mae to benefit from the Department of
Education's servicing contract, under which it would service and
collect government guaranteed loans. Given its low-cost business
structure, we believe this new role will support Sallie Mae's
profitability and help produce an acceptable risk-adjusted
As such, the risk reward profile of Sallie Mae seems balanced
and hence, we have a Neutral recommendation on the stock.
Additionally, Sallie Mae retains a Zacks #3 Rank, which
translates into a short-term Hold recommendation.
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