Sallie Mae Loan Quality, Funding Key Concerns For Investors

Credit quality and adequate funding remain key concerns for SLM Corp. (SLM) investors as the largest U.S. student-loan company reports first-quarter results on April 22.

These concerns come amid the lender's continuing struggles to access traditional funding sources, which have dried up because of tight credit markets.

The company, commonly known as Sallie Mae, earlier this month said it would create 2,000 jobs by bringing its overseas operations to the U.S. The move, say analysts, was aimed at garnering political support amid a budget proposal by the Obama administration that would diminish the role of private lenders, such as Sallie Mae, in federal student loans -- potentially eliminating a vital source of income.

Sallie Mae shares recently traded at $5.99, down about 33% so far this year.

Sallie Mae, which makes private and federal student loans, gets nearly one-third of its income from the federal student loans it makes on behalf of the government.

It earns another third of its income from the interest it charges on private student loans; the remaining one-third comes from a number of smaller businesses, including fees from college savings plans and collecting defaulted student debt.

"From an earnings standpoint, people will be looking for credit quality on the private loans," says Sameer Gokhale, an analyst at Keefe, Bruyette & Woods, who has a 'buy' rating on Sallie Mae's shares. "Liquidity is also a primary concern."

Private student loans, which aren't guaranteed by the government, are riskier - and more profitable - than federal loans. But private loan volume has declined because of the freeze in the credit markets where lenders like Sallie Mae would fund these loans.

Analysts polled by Thomson Reuters expect earnings of 18 cents a share on revenue of $787 million for Sallie Mae's first quarter. A year ago, the company reported earnings of 34 cents a share on revenue of $838.5 million.

Investors will be looking for increasing signs of wear and tear in the company's portfolio of private student loans.

KBW's Gokhale estimates that net charge-offs - or student loans deemed uncollectible - will total $266 million on Sallie Mae's private loans, compared with $216 million in the fourth quarter and $119 million a year ago.

The charge-off rate will total 5.4% for private in the first quarter, according to KBW estimates, compared with 4.46% in the fourth quarter and 3.29% a year earlier.

Also eagerly awaited: an update on an imminent funding source from the U.S. Department of Education. Through this asset-backed commercial paper facility, Sallie Mae could fund as much as $16 billion of federal student loans, says KBW's Gokhale. "This would alleviate some funding pressures."

The lender had $34 billion in private loans at the end of the fourth quarter and $146 billion in federal student loans. It originated $4.8 billion in student loans in the fourth quarter. Of these, new federal student loans totaled $3.9 billion, a 25% increase from a year earlier.

It's no wonder, then, that the Obama administration's proposal to eliminate the income that Sallie gets on federal student loans has investors worried.

One silver lining: The Obama budget proposal requires the participation of private lenders for the servicing of the federal student loans.

-By Aparajita Saha-Bubna, Dow Jones Newswires; 617-654-6729; [e-mail]